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An E.U. Financial Transaction Tax and the Unintended Consequences for Risk Management

In the aftermath of the subprime crisis in the U.S. and the sovereign debt crisis in Europe, the opportunity for establishing a financial transaction tax (FTT) has become a topic of debate in the European Union. In this article, we survey the literature dealing with the possible theoretical and empirical implications of such a tax on market volatility. We then turn to the possible — and unintended — consequences of an FTT on savers and investors. We conclude that these consequences might outweigh the benefits of the FTT. More specifically, we find that an FTT is unlikely to meet its stated volatility control and revenue raising objectives, i.e., an FTT is unlikely to decrease volatility, and indeed, volatility might increase as markets became less liquid. It might raise very little revenue and could work to create more risk and deter long term investment. And then there are serious unintended side effects to consider. Most importantly, for the financial security and safety of the whole financial system, an FTT might heavily penalize pension funds, as well as the banks in their liquidity management and risk management activities, to the detriment of a well-functioning financial system.