Germany wrong on financial transaction tax

Two reforms we do not need are a transaction tax and the regulation of hedge funds - warns academic

In the midst of a eurozone sovereign debt crisis - caused largely by government profligacy - it is not surprising, but it is regrettable, that the German Finance Minister should call for more financial regulation and a transaction tax. It seems that the European Union elite want to use the financial crisis and its aftermath to do everything they can to centralise further power within Brussels. If it were the case that the financial crisis had nothing to do with regulators and central bankers, and if it could be shown that increased levels of financial regulation would prevent such crises happening again, at least the finance minister might have an arguable case. But, not only were international financial regulation, government policy failures in the United States and mistakes by central bankers very much causes of the crisis; the current problems in the eurozone surely shows the folly of responding to state failure with more government regulation and taxation. These proposals are diversions from the main issues and fundamentally misguided.

With regard to the transaction tax, there is no evidence that a transaction tax would achieve its desired objectives – although, there is much evidence that it would be highly damaging to liquidity, raise costs for end consumers in financial markets and damage economic growth. Indeed, even the EU's own estimates suggest a 1.8 per cent drop in the value of economic output from such a tax. And it is highly doubtful that it would raise much money. It is commonly argued that a transaction tax would stop harmful transactions and ensure that finance served the common good.

This is entirely wrong. A transactions tax would actually weigh more heavily on primary equity transactions than on derivatives. In general, a transaction tax is a terrible idea for voters - but great for politicians. It is literally impossible to work out who would actually bear the underlying pain from a transaction tax. Would it be workers, banks' customers, pension fund members or bank shareholders? We have no idea – though it is very unlikely to be banks' senior managers, who seem to be the main target of the wrath of the proponents of such a tax.

There is also no case for regulating hedge funds as the German finance minister suggests. Where was he during the banking crisis? That crisis arose in the regulated sector and was partly caused by the rules that banks faced - encouraging securitisation and discouraging the monitoring of risk. Those banks and other financial institutions that operated outside the regulated sector did not cause problems. All the hedge funds that have got into trouble have been dealt with, in an orderly fashion. The EU should focus on ensuring that banks that get close to insolvency can fail, in an orderly fashion. There is nothing that is more important than this when it comes to reforming financial regulation. We know from experience that the more the financial sector is regulated, the more and more complex it becomes as financial institutions try to find ways around the laws.

There are enough important issues for Europe to be getting on with without taking ever-more powers within its central institutions. It might consider, for example, whether investment in EU government bonds should be favoured by bank capital regulation. If the eurozone is to survive, its members need to agree to fundamental reforms. However, two reforms we do not need are a transaction tax and the regulation of hedge funds. Hedge funds did not take us into this crisis and we did not get into this crisis because governments taxed too little.

Philip Booth is professor of insurance and risk management at Cass Business School, in the United Kingdom