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Economic Watch Latam • Financial taxes have performed reasonably well as a cheap method of gathering resources in Latam, but side effects raise questions regarding their toll on the overall economy The increase in the cost of involving in a formal transaction gives incentives to informality and disintermediation, which can be seen in the increasing levels of cash preference and interest rate spreads. It also raises the cost structure of firms working within the formal sector. These consequences can be extrapolated and used as a guideline for policy makers interested in analyzing the effects of financial transaction taxes in general. • Those considering adopting a financial tax should clarify its main purpose, whether it is recollection or regulation If it’s the latter, there might be better alternatives that don’t imply a financial burden on the agents of the economy. Chart 1 Financial transaction taxes revenue as % of GDP 2.0 1.6 1.2 0.8 0.4 ARG BRA CHI COL PER 2010 2009 2008 2007 2006 2005 2004 2003 0.0 2002 Miguel Poblete [email protected] An overview of the experience with banking transaction taxes in Latin America 2001 Economic Analysis 2000 Madrid, October 29, 2012 VEN Source: BBVA Research, MECON (Argentina), Receita Federal (Brazil), SII (Chile), DIAN (Colombia), Sunat (Peru), Seniat (Venezuela) Taxes considered: Argentina: Impuesto sobre los créditos y débitos bancarios Brazil: Contribuição Provisória sobre Movimentação ou Transmissão de Valores e de Créditos e Direitos de Natureza Financeira (CPMF) Chile: Impuesto a los actos jurídicos Colombia: Gravamen a los Movimientos Financieros (4x1000) Peru: Impuesto a las Transacciones Financieras (ITF) Venezuela: Impuesto al débito bancario (IDB) The author would like to thank the helpful comments from the Emerging Economies and Regulation and Public Policies Units that supported the development of this report. Economic Watch Madrid, October 29, 2012 An overview of the experience with banking transaction taxes in Latin America In the aftermath of the last financial crisis, a number of propositions have arisen as potential measures to regulate financial markets. An alternative presented by the European Commission is the introduction of a financial transaction tax. This tax would affect transactions of financial instruments in where at least one of the participants is located in the European Union. As some EU countries are pushing for such measures to be approved soon, it makes sense to analyze the experiences of regions that have already implemented taxes on financial transactions (FT) to consider its pros and cons. There are three main types of financial transaction taxes that have been applied throughout the world: i) taxes on bank transactions, that is, taxes that apply to movements on debit and/or credit accounts, ii) taxes on currency transactions, like the Tobin tax, which applies to spot conversions of currencies, and iii)taxes on the trading of securities. The first category is also classified as a banking tax while the other are also referred to as non-banking taxes. Even though all these taxes have different scopes and intents, their effects on the markets bear some interesting analogies. Latin America has a long history with financial transaction taxes, more particularly with banking taxes. Here we are going to look at the cases of Argentina, Brazil, Colombia, Peru and Venezuela, who have or have had taxes on almost all transactions done through the banking system, Chile, who taxes some credit transactions, and Mexico, with a tax on cash deposits. It is important to remark that all these are banking transaction taxes, which makes them inherently different from the EU proposal, where a non-banking tax is being analyzed, but some of the lessons learned in Latin America could serve as a guideline for European policy makers. The predominant reason for applying a tax on financial transactions in Latam countries has been to increase government revenue, especially in periods where fiscal deficits reached worrisome levels (e.g. Argentina in 2001-2002, Venezuela 2002-2005). In Chart 1 we can see that this policy had the desired impact, generating non-insignificant revenue levels even in years of economic turmoil. These taxes have the additional benefits of low collection costs (not only for the government, but also to financial institutions who, in most cases, act as withholding agents), and being rapidly available, having thus a quick and consistent effect on fiscal funds. A second, important reason is to prevent tax evasion. In countries with high informality, a tax on financial transactions serves as a way to monitor whether the declared revenues and expenditures are consistent with the actual amounts involved in the trades. Also, depending on the nature of the FT, it helps to prevent related illegal activities such as money laundering. On the other hand, several negative effects have arisen. The most important is that it has increased the levels of cash usage, informality and disintermediation. This has been a problem especially considering that some of these countries already had low levels of formality and bank penetration. The reason is straightforward: it increases the cost of involving in formal financial transactions. A clear way to notice these effects is by looking at the differences in cash preference between periods where the tax has been active or inactive. For that purpose, check Charts 2 and 3 below. REFER TO IMPORTANT DISCLOSURES ON PAGE 5 OF THIS REPORT Page 2 Economic Watch Madrid, October 29, 2012 Chart 2 Chart 3 Argentina: Liquidity preference (cash/total liquidity)* Venezuela: Liquidity preference (cash/total liquidity)* 20% 35% 30% 15% 25% 20% 10% 15% 10% 5% 5% * Shaded areas represent periods where the FT was active Source: BCA, Indec and BBVA Research Jul-10 Jan-12 Jul-07 Jan-09 Jan-06 Jul-04 Jul-01 Jan-03 Jul-98 Jan-00 Jul-95 Jan-97 0% Jan-94 Jan-88 Sep-89 May-91 Jan-93 Sep-94 May-96 Jan-98 Sep-99 May-01 Jan-03 Sep-04 May-06 Jan-08 Sep-09 May-11 0% Source: BCV and BBVA Research In the same vein, some countries have seen increases in interest rate spreads (loans vs. deposits) as a way to cover the greater costs implied. A tax on transactions increases the cost structure of firms working within the formal sector. This has a cascade effect, especially in cases where the tax applies to the majority of the operations executed in the financial sector. As a consequence, it also has a detrimental effect on outsourcing. Finally, the handling of the collected funds has raised a number of doubts. Even though in some cases the taxes were designed to gather resources to tackle particular problems, there is always the incentive to reallocate these extra resources to other areas. This happened in Brazil, where even though the revenues were (by law) meant to be spent only in health, social security and poverty programs, approximately 18% of the funds were used for other purposes. The case of Mexico deserves special attention. Since the tax is on cash deposits it has the opposite effect on liquidity (payment by cash becomes more costly), but the effects on formality are not straightforward as, on the one hand it encourages the use of alternative means of payment, but it also prevents firms and people from using financial institutions. REFER TO IMPORTANT DISCLOSURES ON PAGE 5 OF THIS REPORT Page 3 Economic Watch Madrid, October 29, 2012 Table 1 Obtaining credit or funding using a bank account by willingness and reasons % of total by stratum of employed personnel Stratum of employed personnel Total 0 to 10 employees Access to credit or funding Use of a bank account D. Those that did not C. Those obtain funding that did not because lack A. Those who B. Those that obtain funding of interest obtained bank obtained nonbecause of or distrust in credit bank funding other reasons banks G. Those G. Those without a without a E. Those who bank account bank account use a bank because of lack because of account of interest other reasons 4.9% 23.0% 22.2% 49.9% 19.4% 48.6% 32.0% 4.1% 23.0% 23.0% 49.8% 16.7% 50.1% 33.1% 11 to 50 employees 18.7% 23.1% 5.8% 52.4% 75.7% 16.7% 7.6% 51 to 250 employees 30.7% 22.5% 2.0% 44.8% 90.9% 6.0% 3.1% 251 and more employees 29.1% 24.7% 0.0% 46.2% 95.3% 3.1% 1.5% Voluntary Rationing Involuntary Rationing Source: Castellanos, S. G., Morales, F. J. y M. A. Torán, “Analysis of the Use of Financial Services by Companies in Mexico: What does the 2009 Economic Census tell us?”, BBVA Research Working Paper Number 12/16, July 2012 Also, it is worth noting that the Mexican tax (as well as in other Latam countries) is credited against the general Income tax, so taxpayers can ask for a refund if retentions exceed obligations. However, that doesn’t make it neutral, as it affects the taxpayer’s cash flow and disposable income. With all this in mind, we are left to wonder how effective financial transaction taxes are. They seem to have performed reasonably well as a cheap method of gathering resources, but the side effects, especially on formality and cost structures, raise questions regarding their toll on the overall economy. That leads us to think that the appropriate question for anyone intending to impose a FT is to clarify its main purpose, whether it is recollection or regulation, because if it’s the latter, there might be better alternatives that don’t imply a financial burden on the agents of the economy. REFER TO IMPORTANT DISCLOSURES ON PAGE 5 OF THIS REPORT Page 4 Economic Watch Madrid, October 29, 2012 DISCLAIMER This document and the information, opinions, estimates and recommendations expressed herein, have been prepared by Banco Bilbao Vizcaya Argentaria, S.A. 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