The furious and the fast: Financial innovation encouraged by financial sector taxes

This paper analyses financial innovation as a response of financial market participants to financial sector taxation. Recently, the resentment of a “furious” public against expensive bail-outs of banks has given new momentum to political discussions about the introduction of a “Robin Hood” tax on financial transactions. Most prominently, the European Commission has presented a proposal for a common system of financial transaction taxes. This and other initiatives have had to endure criticism as regards the probability of fast tax circumvention and avoidance activities by financial market participants.

However, so far this discussion has lacked hands-on evidence about how market participants have circumvented financial sector taxes on past occasions. In fact, such taxes have a history almost as long as that of financial markets. Hence, there exists a broad, yet episodic, literature on taxes such as the UK stamp duty or the former German Börsenumsatzsteuer, and how they encouraged financial innovation.

This study draws on the fragmented literature in this field and the rich experience with financial sector taxation to provide a comprehensive and practical review of financial innovation in the context of such taxation efforts, compared to the well-known phenomenon of market participants relocating. This overview exemplifies how a furious public, trying to tap profits generated in financial markets, had to acknowledge time and time again that the financial sector was simply too fast: market participants adopted new trading strategies or introduced new products outmanoeuvring policy-makers’ efforts. The upcoming of depository receipts or contracts of differences are cases in point. More generally, this study might provide important facts for assessing the potential impact of introducing a tax on the financial sector. Current proposals would certainly have to face the sector’s creativity.