Chapter

6 Securities Transactions

Author(s):
Howell Zee
Published Date:
April 2004
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Author(s)
John King

Securities transactions taxes (STTs) are taxes imposed on the transfer of a financial instrument from one owner to another. These taxes are found in more than half of all countries in the Organization for Economic Cooperation and Development (OECD) and in many less developed countries as well. In the last two decades or so, however, there has been a clear trend away from the use of STTs: several OECD countries have abolished them or reduced their rates (as shown in Table 6.1).

Table 6.1Securities Transactions Taxes on Share Transfers in Selected Countries
CountryRate (percent)Nature of taxRemarks
AustraliaTerritory dependentTransactions tax
Austria0.15Transfer taxMay be avoided by trading off-exchange.
Belgium*0.17Stamp taxLevied on both buyer and seller; may be avoided by trading off-exchange.
CanadaNo tax imposed.
FinlandNo tax imposed.
France*[0.15]Trading taxProgressive rates, as described in the text.
Germany*Securities turnover tax eliminated in 1991.
Hong Kong SAR0.20Stamp taxRate reduced in 2001 from 0.225 percent.
Italy*0.14Stamp taxOn domestic off-exchange transactions.
Japan*Sales tax (0.3 percent) eliminated in 1999.
MalaysiaStamp tax (0.3 percent) eliminated in 1992.
NetherlandsNo tax imposed.
New ZealandTransactions levy eliminated in 1992.
NorwayNo tax imposed.
Singapore0.1Contract stampStamp tax (0.2 percent) eliminated in 1992.
SwedenNo tax imposed.
Switzerland*0.15Stamp taxMay be avoided by trading ex-country.
United Kingdom*0.5Stamp taxAlso, a “stamp duty reserve tax” exists.
United States0.0033Securities feeS.31 of the Securities Exchange Act.
Sources: Data for the mid-1990s are from UBS Phillips & Drew, as presented in Suzanne Hammond (ed.), Securities Transaction Taxes: False Hopes and Unintended Consequences (Chicago: Catalyst Institute, 1995), pp. 12-13. For countries marked with an asterisk (*), this information has been updated using data in Karl Habermeier and Andrei Kirilenko, “Securities Transaction Taxes and Financial Markets,” in Patrick Honohan, ed., Taxation of Financial Intermediation: Theory and Practice for Emerging Economies (Washington: World Bank, and New York: Oxford University Press, 2003), pp. 325-43.
Sources: Data for the mid-1990s are from UBS Phillips & Drew, as presented in Suzanne Hammond (ed.), Securities Transaction Taxes: False Hopes and Unintended Consequences (Chicago: Catalyst Institute, 1995), pp. 12-13. For countries marked with an asterisk (*), this information has been updated using data in Karl Habermeier and Andrei Kirilenko, “Securities Transaction Taxes and Financial Markets,” in Patrick Honohan, ed., Taxation of Financial Intermediation: Theory and Practice for Emerging Economies (Washington: World Bank, and New York: Oxford University Press, 2003), pp. 325-43.

Many STTs take the form of duties that are payable for an official “stamp” that must be attached to the transfer document if it is to be admissible as legal evidence of the change in ownership of a financial instrument. Such stamp duties have a very long history, having originated in the Netherlands in the seventeenth century.1 STTs do, however, take a variety of different forms and may be referred to as—among other things—“transactions taxes,” “trading taxes,” sales taxes, and fees.2

Nature of the Tax

As a matter of form, an STT may be levied on the purchaser of a financial instrument (as in Ireland and the United Kingdom); on the seller (as in Japan, before its STT was eliminated in 1999); or separately, on both purchaser and seller (as in Belgium and France). In some countries (such as Italy and Switzerland), the tax is levied on the exchange or brokerage house responsible for the transaction.

Tax Rates

In most cases, STTs are proportional ad valorem taxes on the value of the purchase (or the sale) of a financial instrument. In some countries, however, the rate varies according to the value of the transaction. In France, for example, transactions below a certain threshold are exempt from the STT; above that threshold, a rate of 0.3 percent is applied to both purchases and sales, up to a certain value; transactions above that value are subject to a lower rate of 0.15 percent; finally, there is a ceiling on the total amount of tax for each transaction. Belgium also has a ceiling: for transactions above the ceiling, the STT is a fixed charge for each transaction, irrespective of its value.

Tax Base

STTs vary widely in respect of the base to which the tax rate is applied.

  • Equity and debt. Most countries apply an STT only (or primarily) to transactions involving equity shares, but some also apply the tax to transactions involving debt instruments such as bonds and debentures. In countries such as Belgium that apply an STT to debt instruments, the rate is usually lower than the rate applied to shares.
  • Primary and secondary markets. The STT may be applied only to transactions of existing financial instruments in the secondary market or to new issues in the primary market as well. In some countries, new issues are subject to a separate tax.
  • Cash versus derivatives markets. STTs may be applied both to cash transfers of securities such as shares and bonds and to transfers of derivatives such as options and futures. Thus, some countries levy STTs on purchases or sales of an option, according to the option price (in addition to the tax on the transaction in the underlying security, in cases where the option is exercised).
  • Domestic and foreign securities. STTs may be levied only on transfers of domestically registered securities or on transfers of both foreign and domestic securities. In the latter case, different rates may be applied. For instance, Switzerland’s stamp duty is levied at 0.15 percent on transactions in Swiss securities, and at 0.3 percent on transactions in foreign securities by those who are not members of the Swiss exchange.
  • Domestic or foreign market participants. The STT is sometimes applied differentially, depending on whether purchasers or sellers are residents or nonresidents. In Belgium, for example, nonresidents are exempt from the transactions tax; in France, they are exempt when trading on the Paris Bourse.
  • Exemptions. Market makers who act as intermediaries between buyers and sellers are commonly exempt from the STT or subject to reduced rates. In Italy, the exemption is broader: the STT is applied only to transactions that take place outside a formal stock exchange. In other countries, however, the STT is confined to transactions made through a broker. Exemption may also be extended to transactions by certain institutional investors (such as investment funds, social security funds, private pension funds, and life insurance companies).

Main Economic Effects

There is little controversy about the two main effects of an STT on financial markets. In principle—like an excise tax imposed on transactions—it can be expected to reduce the volume of transactions in the financial instruments that are subject to the tax and the price of those instruments.

Volume Reduction

An STT increases the cost of making the relevant transactions. The cost of sales of equity shares from one investor to another through a broker (including brokers’ commissions on both the sale and the purchase, but excluding STTs) may be as low as 30 basis points for typical transactions by institutional investors in the United States, where financial markets are most highly developed.3 In the European Union (EU) and Japan, corresponding figures lie between about 50 and 70 basis points. Even when levied at what might appear to be modest rates, STTs can substantially increase such costs. For example, in the United Kingdom, the 0.5 percent stamp duty that is levied on purchases of shares roughly doubles transactions costs—from about 50 to almost 100 basis points.

This increase in cost will affect the volume of transactions in three main ways. First, if the tax cannot be avoided, many transactions that would have taken place in the absence of the STT will simply not take place at all. Consider a single transfer of a particular share from investor A to investor B. A places a value of not more than VA on the share; B places a value of at least VB.4 Transfer of the share from A to B will take place where

VB - VA > C

where C is the total cost of the transfer. In any period of time, the volume of market transactions will therefore depend positively on factors that cause investors to differ in the valuations that they place on particular shares and negatively on the total cost of making those transactions.

Second, it may be possible to avoid STTs by moving the same transaction elsewhere—for instance, outside the regular exchange or to an exchange overseas. In general, additional costs are associated with such a move, but they may well be lower than the STT.

Third, it may be possible to avoid STTs by changing the transaction to something that is roughly equivalent in its effects. For instance, if an STT is imposed on transactions in some assets (such as company debentures) but not on those in other, similar assets (such as government bonds), the STT is likely to decrease the volume of transactions in the former market but increase it in the latter market. In some cases, financial markets may be able to create new assets that are very close substitutes but that are not themselves subject to the STT.

A number of econometric studies have investigated the responsiveness of trading volume in financial markets to changes in transactions costs (including STTs)—in particular, in Sweden, the United Kingdom, and the United States. In general, the results of these studies are consistent with a significant negative response. The estimated elasticity of response in the long run varies quite widely between different studies, however, from about -0.25 to -1.7.5

Price Reduction

Owners of financial instruments generally do not expect to hold them indefinitely. At some point, those instruments will be sold. If the purchasers are required to pay an STT, they will—other things being equal—demand a lower price for the asset. If future prices are reduced in this way, however, the present price of the asset would also be lower than it would otherwise have been. Thus, the market prices of the financial instruments to which STTs are applied can be expected to drop. From a different perspective, the cost of raising capital will go up when new financial instruments subject to STTs are issued.

There is substantial empirical support for the view that higher trading costs, in general, tend to reduce asset prices. Studies of the effects of STTs, in particular, also support this finding. Simple observations of the behavior of equity prices on the announcement of new STTs or rate increases are also consistent with this result. In Sweden, for instance, the All-Equity Index fell by 2.2 percent on October 24, 1983, when a 1 percent STT was first announced; and it fell again by 0.8 percent on March 11, 1986, when it was announced that the rate was to be raised to 2 percent. On the day in 1974 when the stamp duty rate in the United Kingdom increased from 1 percent to 2 percent, the stock market index declined by 3.3 percent.

Derivatives Markets

The effects of STTs on derivatives markets, such as the options market, are very complex, but a general conclusion is not likely to be controversial: even if the STT is levied only on transactions in the underlying assets and not on sales or purchases of the derivative, it is likely to severely affect the growth of such markets.

An options contract, by itself, is very risky for both the buyer and the seller. A financial institution seeking to create a market for options contracts will, therefore, hedge its risk, generally by requiring that the market maker engage in transactions in the underlying asset. If those transactions are subject to an STT, the cost of supplying an option contract—and, hence, the price of the contract—will increase.

Benefits and Costs

Although the broad economic effects of STTs are reasonably straightforward, the implications of those effects, and their desirability, have proved very controversial indeed. STTs have long had strong critics and strong supporters among economists.6

Benefits

The most obvious benefit of an STT (as with any tax) is the revenue that it raises, which reduces the need for the government to raise revenues from other sources or to cut spending—neither of which is a costless option. In addition, advocates of STTs view the reduction in trading volume that the tax would bring as likely to be of benefit to the economy. In an early statement of this position, J. M. Keynes wrote:

It is usually agreed that casinos should, in the public interest, be inaccessible and expensive. And perhaps the same is true of Stock Exchanges…. The introduction of a substantial Government transfer tax on all transactions might prove the most serviceable reform available, with a view to mitigating the predominance of speculation over enterprise in the United States.”7

There are two main aspects to the possible benefit of a reduction in trading volume. The first is that it would reduce the resources that are devoted to some types of trading that STT advocates see as having no social value. For example, if a trade takes place only because the buyer and the seller have different expectations about the future performance of a security, then the expectations of at least one of them must be wrong. In this case, it could be argued that society as a whole should be indifferent as to which of the two holds the security and that any resources that are devoted to transferring it from one investor to the other are wasted resources. Against this view, a standard presumption in economic analysis is that, if two individuals freely choose to exchange an asset at a given market price, then it may be inferred that both gain “utility” from the trade—and the welfare of society is therefore increased. The different circumstances in which individuals may find themselves provide ample grounds for expecting that they will, at any time, attach different values to the same asset.

Second, it has been claimed that a reduced trading volume will reduce the volatility of share prices, since the STT on share transfers particularly penalizes speculative “noise traders,” whose purchase and sale decisions are based on price movements rather than fundamental information. But this claim, too, has proved controversial. A number of theoretical models have been developed in which the effect of an increase in transaction costs (such as an STT) has the effect of increasing, not reducing, the volatility of prices. Ultimately, however, the issue is an empirical one and there has been no clear empirical support for the view that STTs reduce volatility in financial markets.

Costs

The main costs attributable to an STT have already been mentioned above. In particular, the tax can be expected to raise the cost of capital for enterprises seeking to raise funds by issuing the securities whose transfer is subject to the STT (and so distort the choice by an enterprise between different ways of raising capital, insofar as the STT is levied on some forms of security and not on others), and reduce the efficiency with which the existing stock of those securities is distributed between potential holders. In addition, an STT could be harmful to the development of the domestic financial industry by reducing socially desirable transfers of securities, driving transactions in the taxed securities offshore to competing markets, and inhibiting the development of domestic markets in new instruments (such as options to buy or sell the securities subject to the STT).

Incidence

It is very difficult to ascertain who ultimately bears the burden of an STT. To begin with, the formal responsibility for paying the tax (which different countries assign to the purchaser, the seller, or both—or to the broker who intermediates the sale) does not generally determine its ultimate incidence, because the market prices of the taxed securities are likely to adjust according to where the payment responsibility is assigned, which is largely dictated by considerations of convenience and administration rather than a decision on who should ultimately bear the burden of the tax.

Beyond that, the main factor influencing the incidence of an STT seems to be that it reduces savers’ returns from holding the taxed instruments and, hence, increases the cost of capital for investors who use those instruments to raise new funds. Because the prices of different assets can be expected to adjust in such a way as to equate expected (net) returns on different assets, these differential effects on returns from particular kinds of assets will tend to be generalized to all assets. Thus, the burden of an STT is likely to spread to all asset holders—including holders of assets that are not directly subject to the STT. The ultimate incidence of an STT is, thus, not transparent.

This lack of transparency may be seen as a disadvantage of an STT. However, it may sometimes also make the tax attractive as a simple and rough method of taxing those who earn income from capital when other, more precisely targeted taxes—such as a capital gains tax—are seen as difficult to implement effectively.

Revenue Potential

Even in countries with highly developed securities markets, STTs do not raise significant amounts of revenue. In the United Kingdom, the stamp duty on share transfers raised about 0.12 percent of GDP and about 0.35 percent of total tax revenue annually in the mid-1970s—when it was levied at the comparatively high rate of 2 percent. The rate was reduced to 1 percent in 1984 and reduced further to 0.5 percent in 1986 (when the duty was extended, in the form of a stamp duty reserve tax, to cover transactions in shares without an instrument of transfer). By the end of the 1990s, the total duty on share transfers in the United Kingdom was raising about 0.4 percent of GDP a year, or a little over 1 percent of total tax revenue. Estimates that were made in the United States in 1990 of the potential yield of an STT of 0.5 percent were in the range of 0.12-0.17 percent of GDP, or 0.67-0.95 percent of yearly tax revenue.

These figures do not take account of the ways an STT would reduce revenues from other taxes. In particular, in countries where capital gains on financial securities are subject to tax, an STT increases the cost basis of the securities (if the purchaser is liable for the tax) or reduces the net proceeds from the sales (if the seller is liable). If capital gains are taxed at 30 percent, only 70 percent of the proceeds of an STT will represent net revenues to the government—even if the tax has no effects on prices or volumes. Revenues from the capital gains tax are reduced further if the STT reduces securities prices (thus reducing gains on the securities) or the volume of securities transactions (thus increasing the average lag between the accrual of gains and their realization).

Administrative Aspects

STTs are usually simple and inexpensive to collect—and are becoming even more so as the technology employed in financial markets improves. In the United Kingdom, for example, the collection cost of stamp duties is about 0.12 percent of revenue collected,8 compared with an average of between 1 and 2 percent for other taxes. Because STTs are simple, compliance costs for taxpayers and their agents are also likely to below.

An advantage that has often been claimed for STTs—particularly in the form of stamp duties on transfer documents—is that the information they generate for the government about individual securities transactions can be valuable in assessing liabilities to other taxes, such as capital gains taxes and income taxes. This benefit depends, of course, on the extent to which effective use can be made of the information that is generated.

Finally, STTs vary quite widely in the ease with which they can be avoided. As noted earlier, taxes levied on transactions made through a stock exchange can be avoided (at some cost) by transacting outside the exchange. Many STTs can be avoided by moving the taxable transactions offshore. And taxes that are based on the registration of documents can be avoided in a variety of ways—by holding securities in bearer form or in the form of derivative instruments such as American Depository Receipts. There are, of course, things that a tax authority can do to counter these avoidance strategies: for example, some countries apply a much higher rate of STT to transactions that convert registered shares into bearer shares. Nevertheless, it may reasonably be supposed that the financial community will continue to seek new ways to minimize the impact of STTs.

1

They are commonly levied on transfers of property as well as on financial instruments. Indeed, several OECD countries (including Germany and the Netherlands) that have abolished STTs have retained a tax on transfers of real property. Property transfer taxes are not covered in this paper.

2

The United States abolished a federal stamp tax on the sale of common stock and corporate bonds in 1965. However, a small Securities and Exchange Commission (SEC) fee is levied on transfers of corporate stock, at a rate of 0.0033 percent. Because the proceeds of this fee accrue to the federal government and are roughly five times the amount that is actually allocated to the SEC for its own expenditures, it is commonly classified as a tax.

3

The actual figure is likely to vary considerably from one transaction to another, since these costs do not depend significantly on the value of the transaction. Hence, commissions represent a much larger percentage of the value of small transactions than of large transactions.

4

These different valuations may reflect different expectations about the future performance of the share. They may, however, result from many other factors. In particular, if the two investors have different portfolios, the share may increase the overall risk of A’s portfolio or reduce the overall risk of B’s portfolio.

5

To give an idea of the magnitudes involved, suppose that the initial transactions volume is 100, and the transactions cost (before the introduction of a tax) is 0.5 percent. Introducing a new STT at 0.5 percent on purchase or sale will then double the transactions cost to 1 percent. If the elasticity is -1 over the relevant range (so that the proportional reduction in volume will be equal to the proportional increase in cost), doubling the cost will halve the volume to 50. If the elasticity is -0.25, the volume of trading will fall from 100 to 84.1; if the elasticity is -1.7, it will fall to 30.8.

6

Many of the issues reviewed below are discussed in more detail in the various articles in Suzanne Hammond (ed.), Securities Transaction Taxes: False Hopes and Unintended Consequences (Chicago: Catalyst Institute, 1995).

7

J. M. Keynes, The General Theory of Employment, Interest, and Money (London: Macmillan, 1936), pp. 159-60.

8

This figure covers stamp duty on property as well as on shares. It also covers the stamp duty reserve tax as well as traditional stamp duty on documents.

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