When ideology meets economic reality (part III): Germany squabbles over the Financial Transaction Tax

The Bundesbank, The Deutscher Aktieninstitute (DAI), and even EU civil servants from the 11 participating countries have all warned against the FTT in its current form.

Today saw yet another German voice raised again the tax – this time from the very party that is meant to be its greatest champion. Nils Schmid, Baden-Württemberg's Minister of Finance – from the German social democrats (SPD)— wrote a letter to German Finance Minister Wolfgang Schäuble condemning the FTT in its current form as “rubbish.” Ouch.

Schmid’s intervention, says that "If the financial transaction tax is implemented as is currently planned, initial estimates show that it is likely to have a serious impact on certain segments of the market (money and capital)." He then calls for a “proper configuration” of the FTT.

So why is this important? Twofold:  first, it shows that in light of the overwhelming evidence of the negative economic impact of the FTT in its current form, the support for the proposal is quickly evaporating.

This now extends to the German political parties that have strongly endorsed it. Remember, the FTT is one of the SPD’s main campaigning issues, and served as the party’s quid pro quo for accepting the EU fiscal treaty. Although Schmid caveated his position, saying that he is not opposed to the idea of a FTT in theory, the point has most definitely been made.

Secondly, the FTT controversy has legs to become battleground ahead of the German elections in September. It is an issue that may split politics, both, within the parties and on a national level.

Officially, Schmid’s letter was met with a standard diplomatic line from the German Finance Ministry – which says it is taking concerns raised by Schmid and German banks “seriously.” They won’t say so in public, but the German finance ministry was most likely nodding approvingly…

Meanwhile, deputy chairman of the FDP parliamentary group ,Volker Wissing, saw his opportunity to strike – and took it, saying that Schmid's letter shows with which "naivety" and "rose-tinted blindness", the SPD had driven the demand for a financial transaction tax.

So far the SPD have remained stumm on Schmid’s intervention. But watch this space. If influential figures within SPD are the latest to start make noises about this, then surely, the Commission’s proposal cannot stand?

"If you had kept quiet, you would have remained a philosopher" - The Commission utterly fails to address flaws in the financial transaction tax

There's an old Latin saying, "If you had kept quiet, you would have remained a philosopher." Reading the Commission's defence of its proposed EU financial transaction tax (FTT), that phrase immediately sprung to mind. It's not the strongest piece, to say the least.

In our continuing quest for transparency, we have published the Commission’s direct response to the concerns raised by the 11 participating FTT member states (docs which we exclusively published last month).

The Commission's response ranges from weak to capricious to outright ridiculous. For example, when it says that "we're not aware of any credit crunch" in Europe. Right...

Arguably the most worrying part of this response is the tone. The Commission is essentially saying ‘we know better’ than financial markets. For example, in dealing with concerns over the impact of the FTT on short term trading, it suggests much short term trading is often “myopic” and that asset managers which trade predominantly in the short term should be subject to less investor demand in transparent markets, despite the success of money market funds and their importance for liquidity.

Now, 'financial markets' are diverse, far from perfect and certainly not always right. However, the Commission would be remiss to just dismiss concerns raised by governments inside and outside the FTT zone - but also actors from across the business and manufacturing community (in addition to virtually every bank in Europe).

We have long suggested that there are three key areas of concern which will have to be addressed before the FTT can even hope of being implemented without huge market distortions – the extraterritoriality, the impact on repo markets and the impact on government (and corporate) bond markets.

Many of the concerns raised by the 11 FTT states - and the Commission's response - related to these issues. Sorry in advance for the length of this post but here are the key points:

Extraterritoriality

As reported this morning, the Commission argues that a “business case” can be created for enforcing the FTT outside the FTT zone. Essentially, exchanges and clearing houses will be responsible for collecting the tax and if they don’t,  the firms in the FTT zone will not want to trade with them.

This is concerning development for a number of reasons:

• First, it will increase tensions and splits within the single market. Financial firms are unlikely to just roll over and accept this. In fact, given the size of the market outside the FTT zone, they could validly refuse to trade with those inside the FTT zone. In any case, the prospects of a scenario similar to that of escalating protectionism in trade dispute cannot be ruled out.
• It also seems very punitive, using alterations in the legislation (the joint and several liability) to enforce it in areas where the tax has already been rejected.
• This also assumes firms do not move out of the FTT zone to escape the tax. This seems unlikely in the first instance, while not being able to trade with those outside the FTT zone if they do not pay the tax (or having to pay their share yourself) seems to make staying inside even less appealing.

The Commission also accepts that double taxation is a concern. However, the proposed solution of setting up agreements on where the tax will fall, seems unlikely especially in the UK’s case since it has launched a legal challenge against the tax.

Impact on government and corporate debt

The Commission also fails to provide much comfort on the impact of the FTT on national debt and borrowing costs. It admits it has been unable to estimate the impact due to lack of info, but further accepts that “Member States might be better placed to have access to such information.”

This raises two questions:

• First, surely legislating on such a sensitive issue without fully knowing the costs on a key area, with many of countries involved in the midst of an economic crisis, is nothing short of negligent.
• Second, if member states are better placed to judge these issues, why does the Commission and the EU need to take the lead and push such a tax in the first place?

Furthermore, we doubt the concerns over ‘redistribution’ will have been assuaged as the Commission accepts that some money from the trading of government bonds will not go to the country that issued them.

This could be of concern for countries such as Spain, Italy or even France which have huge debt markets but whose debt is widely traded around the world and the EU but international firms. It also seems to punish small countries with less developed financial sectors, since the tax will be paid where the bond is traded firstly with the residence principle only kicking in afterwards.

Possibly more worrying is the response to concerns over the corporate debt market. The Commission seems to brush this off, adding that it is “not aware of any credit crunch” with regards to borrowing for businesses. This is despite the clear survey results showing businesses struggle to access credit in many European countries and the many, many press stories on the issue. It surely cannot argue that given the state of the economy, now is the best time to implement the tax.

Repo markets

As we have highlighted this is an area of serious concern. Unfortunately, the Commission continues to persist with a weak counter-argument insisting that repo markets can be easily replaced by secured loans or lending by central banks (while accepting the short term repo market will be all but destroyed by the tax).

This argument is flawed for numerous reasons:

• The market has access to these other instruments but see repo as preferable, the Commission still insists, however, that it knows better.
• Moving more lending to central banks is not desirable! European policy makers are working hard to restore usual financial markets and move lending off central bank balance sheets.
• Without normal functioning markets, monetary policy cannot have an effective impact, while in the eurozone money will not flow cross border and imbalances will continue to build up (any hope of an integrated banking union would be dead).
• Furthermore, all the risks will be taken onto the central banks’ taxpayer-backed balance sheet – surely this is a terrible form of risk being socialised but profit privatised.
• Secured loans do not provide the same level of legal protection as repos. Since collateral is purchased under a repo, if there is a default the collateral has already changed hands. However, under secured loans the claim would go back into normal (lengthy and costly) insolvency proceedings.

The Commission does raise the point that Repos can hurt financial stability, but surely this is more a case for effective supervision and regulation than taxing the market out of existence.

With widespread talk of the FTT being shelved for at least another year, perhaps it's time for the Commission to just admit defeat?

Italian PM launches opening salvo against austerity - but where will the cash come from?

The new Italian Prime Minister Enrico Letta announced his first raft of policies in his first speech to the Italian parliament yesterday. The speech was strong on anti-austerity rhetoric but short on details of how his new approach would be funded - illustrating that ever-so-relevant dilemma in the eurozone (and elsewhere): it's easy to criticise austerity, much harder come up with alternatives. Here are the key points:

·    The government will scrap up to €6bn worth of tax rises, although Letta provided no detail about how this funding gap would be filled. Much of this move was motivated by Silvio Berlusconi’s insistence on scrapping a new housing tax which was laid out as a precondition for the formation of the grand coalition

·    Some phrases which will make German Chancellor Angela Merkel wince, such as: “We will die of fiscal rigour alone. Growth policies cannot wait any longer”, “[Europe faces] a crisis of legitimacy” and there is a need for a “United States of Europe”.

·    Letta believes Italy’s welfare system is inadequate and will look to broaden it to provide further help to women, young people and temporary workers.

·    Businesses will also receive tax incentives to hire young workers.

·    Again no details on how such policies will be funded. La Stampa reports that all in, the “Letta Agenda” could cost €20bn. He made no mention of privatisations or the sorely needed reforms to the labour and product markets to make Italy more competitive.

·    Letta did stress that Italy will meet all of its EU commitments and targets.

·    He set himself and the new government an 18 month window in which to achieve the some success in turning around the economy or “face the consequences”.

·    Promised to reform the electoral law and cut MP’s pay.

A very interesting opening salvo from Letta. In fact, not too dissimilar to French President Francois Hollande’s early comments regarding austerity – we can’t help but wonder if his enthusiasm and/or success will wane in a similar way.

One thing that is clear from the speech is the continuing power of Silvio Berlusconi (as we previously noted). La Stampa suggest up to €12bn of the cost of the ‘Letta Agenda’ actually comes from Berlusconi’s demands, while following the speech Angelino Alfano, the new Deputy PM and key Berlusconi ally, said, “I share the words of Enrico Letta’s speech from the first to the last. It is music to our ears.” Meanwhile, Berlusconi also took the opportunity to this morning ramp up his own rhetoric against austerity, calling for the new Italian government to “renegotiate its deficit commitments” with the EU.

All of this sets an interesting tone and background for Letta’s first meeting with Merkel which takes place this afternoon. As we have noted previously and at length, the key question surrounding this whole austerity debate remains, if not through cuts, then who will pay for the party? Germany and the ECB certainly aren't ready to foot the bill indefinitely and while market sentiment is positive now, it likely could not withstand a new spending spree in a country with a debt-to-GDP of 120% already. We suspect Merkel may make just that very point...

What if the Cypriot parliament votes against the deposit levy?

This is the question which is now holding global financial markets on the edge - could it really happen and what would it mean, we assess the possible scenarios below.

Could the Cypriot parliament vote against the levy?

According to Reuters, Cypriot government spokesman Christos Stylianides told state radio that the vote “looks like it won’t pass”. Meanwhile, via Zerohedge:

• CYPRUS PRESIDENT: PARLIAMENT BELIEVES BAILOUT PLAN UNJUST, GOVERNMENT MAKING OTHER PLANS.
• CYPRUS PRESIDENT: PARLIAMENT WILL REJECT BAILOUT PLAN

As we were tweeting yesterday, the DIKO party (junior coalition member with 8 MPs) had said it would not vote for the deal without some improvements, although we suspect reducing the burden on small depositors could help convince them. The European Party (2 MPs) had previously said it would not support he levy, however, according to CYBC, it has now said it would support the levy if depositors are compensated with interest bearing government bonds (we assume linked to gas revenues, something which the government has already offered).

That said, according to the Cypriot press, the latest proposal sees deposits below €20,000 exempt, deposits between €20,000 and €100,000 taxed at 6.75% and deposits over €100,000 taxed at 9.9% - this is unlikely to satisfy demands to exempt smaller depositors. It also seems unlikely to raise the required €5.8bn, not least because it applies the same rate as the original to a smaller pool of deposits.

Separately, there are conflicting reports this morning on whether the vote will be delayed again. The government is unlikely to put this to a vote until it is almost near certain of getting it through.

What would the fallout be?

The fallout of voting down the package could be explosive and we can only speculate about what could happen next, but its eurozone membership would likely be brought into doubt. As we noted in our flash analysis, there are few other alternatives for Cyprus to raise the necessary cash, while the eurozone has made it clear it cannot foot the entire bill (such an option would make Cypriot debt unsustainable anyway).

The eurozone would likely give Cyprus a few days either to change its mind or come up with an alternative way of financing the €5.8bn. Another parliamentary vote could be held (the EU of course has form when it comes to demanding the 'correct' vote).

The ECB has already reportedly warned that rejecting a levy would have dire consequences. Specifically, the two largest Cypriot banks would go without recapitalisation and could see their liquidity from the ELA (sanctioned by the ECB via the Bank of Cyprus) cut off, leading to them becoming insolvent and collapsing – putting their €30bn of deposits at risk, since the government obviously cannot guarantee them. This would likely bring down most if not the entire Cypriot financial system.

With the financial sector close to or in the process of collapsing and no support forthcoming from the eurozone or ECB, since Cyprus rejected their terms, Cyprus could even be forced to leave the eurozone and begin printing its own new currency, one that would have little international trust and could lead to a spiral of hyperinflation, etc, etc (i.e. a very nasty scenario).

There is, of course, a chance that if faced with the prospect of Cyprus leaving the euro, the rest of the eurozone could blink and find an alternative way to bailout Cyprus but the politics of such a scenario would get very ugly indeed. The ECB may not follow through on its threat to withdraw liquidity for Cypriot banks but this would only be a temporary reprieve. The Cypriot government will run out of cash at the start of June when it needs to pay off a €1.4bn bond, while the banks' position could be worsened by the likely deposit outflows once banks open, even if the tax is not applied.

What are these “other plans”?

It’s not clear exactly what Cypriot President Nicos Anastasiades meant when he suggested the government is making 'other plans'. We have long noted that deeper connections to Russia remain a viable option for Cyprus. With Russia angry at the eurozone for trying to burn some of its depositors, some more financial support could be forthcoming (but maybe only for Cyprus outside the eurozone) – with significant geopolitical implications as we noted here.

Other options which have been bandied around include: a financial transaction tax and the recent proposal from Lee C. Buchheit and Mitu Gulati (the men partly behind the Greek restructuring) to convert deposits into deposit certificates with fixed long term maturities. However, the former has been widely rejected by Cyprus and may not yield sufficient funding. The latter is an interesting proposal but may only offer liquidity support rather than solvency, while the banks would still remain under-capitalised. Such a proposal would still require significant backing from the eurozone and Russia – both of which are likely to come with onerous terms – and present similar obstacles to a deal.

So, all in all a 'No' vote, however tempting to Cypriot MPs, only leaves more drastic alternatives, hence it remains a possible but not probable outcome.

How might a revised Cypriot bailout deal look?

Update 11:00 GMT 18/03/2013

Sources told Spanish news agency EFE that the Cypriot government and the Troika have agreed to cut the levy on depositors with less than €100,000 to 3% and and increased the levy on those with more than that to 12.5%, but we haven't seen this confirmed by anyone else so treat with care.

Update 09:15 GMT 18/03/2013:

The WSJ is reporting that Cyprus could seek a further division amongst uninsured depositors (which @MatinaStevis tweeted already yesterday). According to the paper, the Cypriot government is pushing for 3% on below €100,000, 10% on between €100,000 to €500,000 and 15% on €500,000+. There are no clear figures on how much each individual levy will raise, although Germany is said to be open to the idea as long as the total of €5.8bn remains.

The Cypriot parliament will vote on the deal at 2pm GMT, with eurozone finance ministers due to have a teleconference at some point later this afternoon.

Original post

As we reported yesterday, the Cypriot government is now scrambling to renegotiate the deal which has created such an outcry in Cyprus. Germany and the IMF will not budge on the headline figure or that the money must come from a deposit levy (the only option to raise this sort of cash anyway), however, they do not mind which depositors pay it or at what rates.

This has led to suggestions that the rates could be adjusted to increase the cost on large uninsured depositors and reduce the impact on smaller insured depositors – this would probably be both legally and politically more acceptable.

So how could it be structured? Well, Cyprus has around €30bn in insured deposits below €100,000 and €38bn of uninsured deposits above €100,000. See table below for potential structures (click to enlarge):

Option 1 seems to be what is currently under discussion. Option 2 might be politically popular, although the impact on business and investment could be significant. One thing that is clear, as we have repeated over the weekend, is that this deal remains in flux.

Is there any chance Cyprus could secure a better deal?

UPDATE 22:00 

According to Reuters, German Finance Minister  Wolfgang Schäuble claimed today that it was indeed the Cypriot govenrment's  decision to go for smaller depositors - not Germany's. 

Speaking to public broadcaster ARD he said, 

"It was the position of the German government and the International Monetary Fund that we must get a considerable part of the funds that are necessary for restructuring the banks from the banks owners and creditors - that means the investors."

"But we would obviously have respected the deposit guarantee for accounts up to € 100,000...But those who did not want a bail-in were the Cypriot government, also the European Commission and the ECB, they decided on this solution and they now must explain this to the Cypriot people."

 Let the finger-pointing begin...

ORIGINAL POST

As we have pointed out, the bailout deal and deposit tax are still subject to Cypriot parliament approval, which is far from assured but looks likely.

In any case, questions are arising of whether there is scope to adjust the level or structure of the tax, with reports claiming that the Cypriot government is currently in talks with EU partners to revise the deal, possibly shifting a greater share of the burden to larger depositors. This would make the deal far more politically palatable.

Much of the outcry has been against the 6.75% tax on depositors below €100,000 – mostly 'ordinary' Cypriot savers. The perception is that EU leaders and the IMF imposed this on Cyprus. The question is, if the parliament rejected the deal - or with the threat of it rejecting the deal (still unclear whether there will be a majority for it in the Parliament) - could they perhaps push for the 9.9% rate for depositors over €100,000 to be increased, with a corresponding lower share for the lower end depositors? And are there possible progressive arrangements, involving several different depositor 'brackets'?

It is possible, since technical details are still being ironed out (for example if you have €100,000+ will it all be taxed at 9.9% or part at 6.75%). However, the important point to note is that, although Germany was the driving force behind the tax itself, it seems that the Cypriot government played a role in designing it. Mainly, reports suggest that the Cypriot President Nicos Anastasiades was reluctant to return with a double digit tax on higher deposits as this would anger Cypriot businesses and investors as well as scare of foreign investors. In other words, Cyprus worried that this would kill the country's position as an 'offshore' financial centre.

It has of course been reported that Germany and the IMF were pushing for a double digit tax initially – but on whom? Think about the maths for a second. The current structure raises almost €6bn. The max which the Eurozone was trying to cut of the bailout was €7.5bn. So, with €1.4bn in privatisations the target is reached. Logically this must mean the higher rate would have raised the same amount and therefore been applied to fewer depositors. This simple calculation suggests that the negotiations moved from a higher double digit tax on a specific group to a broader lower tax.

In any case, the important point to note is that the structure of the deal and the decision to hit ordinary depositors may not have been entirely a Eurozone one.

Whether the Cypriot government can or will change its position remains to be seen, but all of this suggests there should be some scope for a revised deal, though it would be far from ideal to keep the details unclear when markets open.

A vote on whether to leave the euro? What's next in Cyprus?

This will be another eurozone nail-biter. 

The deal agreed by eurozone finance minister on Friday to tax Cypriot depositors (and some other conditions) in return for a €10bn bailout still needs to get passed some hurdles. As ever, there's one huge "hurdle": democracy.

The Cypriot parliament needs to approve the deal before it can become reality. The parliament was due to begin debating the issue today, but his meeting has now apparently been postponed. As things stand at the moment, the Parliament is due to hold a vote at some point before Monday night (although we imagine they will be under some pressure to get it done sooner rather than later. Monday is a bank holiday in Cyprus, but markets will be watching).

Here are some key questions about the next steps:

Could the Cypriot Parliament vote the package down?

A statement from the Cypriot President Nicos Anastasiades last night made it clear that he considers a No an effective vote to leave the euro. As in so many of these "desperately needed bailout meets parliament  scenarios, Cypriot MPs will probably be too frightened of the consequences to vote the package down. After all Cyprus is a very small country, having its own free floating currency is probably not a sustainable long term option, especially since leaving the euro would likely see a complete collapse of its banking sector and a very large default – very few people would have much trust in any new currency.

But a No is still not out of the question. As Kathimerini points out, the Democratic Rally (DISY) and the Democratic Party (DIKO), the parties which supported President Anastasiades in his recent election, do not have a majority – only 28 out of 56 MPs. AKEL the main left opposition party (which has 19 MPs) has said it will vote against the package, while DIKO has recently seen at least one MP who does not support Anastasiades split off.

The package may also get support from the European Party (2 MPs), but the Movement for Social Democracy and the Ecological and Environment Movement (5 and 1 MP respectively) have suggested they could vote against the deal.

So, currently the vote could be 30 in favour and 26 against. However, one of the reasons for postponing the vote seems to be to give the government more time to rally support, so it's still a very fluid situation.

What happens if the Parliament rejects this deal?

Unclear. But it could be down to two options: either Germany and other creditor countries soften up the conditions, most likely on depositors, or Cyprus may be forced into default, which most likely means leaving the euro.

Political and popular support may align against the euro

And regardless, much of the population and at least half the political establishment do not seem to support this deal and although there may be few other options on the table in the immediate future, that could seriously undermine the country’s political stability or its long term membership of the Eurozone.

Pushing Cyprus closer to Russia?

As we have noted before, the geopolitics of the situation here are very delicate. Most other small European countries have few alternatives in terms of support structure, however, Cyprus has Russia. Russian support could begin to look increasingly attractive due to fewer overt conditions (although the more covert conditions are likely to be onerous). Comments by certain European leaders over the weekend have suggested the situation in Syria could escalate. As we have pointed out before, Russia has previously sought to move its only naval base in the Mediterranean from Tartus, Syria to Cyprus – an escalation could renew this desire while financial support could provide an avenue to make it happen.

This is of course a distant prospect, but the point is that, the political fallout of this move could be very significant not just within Cyprus but for the EU as a whole. This needs to be handled with utmost care...

Initial thoughts on Spain's latest austerity budget

We’re still waiting for the full breakdown and figures behind the Spanish budget (which we will analyse and post in due course) but in the meantime here are our initial thoughts:

• The decision to tap the pension/social security reserve fund for €3bn was surprising. Generally this is a fairly last resort approach, but why Spain felt the need to do this to get its hands on only €3bn isn’t clear, especially with short term borrowing costs still low. Could Spain’s liquidity problems be greater than thought?
•  The interest Spain will have to pay on its debt will go up by €9.7bn, compared to a total package of cuts of €40bn (undoing almost a quarter of them). For a country the size of Spain even seemingly substantial cuts can easily be offset by the massive debt burden.
• The majority of the savings (58%) will come from spending cuts rather than tax increases – there is an on-going debate over which is more effective but in the short term spending cuts are likely to harm economic growth (especially given the reliance on the state as an economic driver in Spain).
• Tax revenue is expected to go up by 3.8% - given that growth is likely to falter this seems incredibly optimistic, even with some tax increases.
• The basic macroeconomic forecasts for the budget haven’t changed – this suggests that the overly optimistic growth forecasts are likely still in place, despite most investors and international agencies reducing their forecasts.
• Unemployment is predicted to have topped out this year – again this seems hopelessly optimistic given that structural labour market reforms are yet to take full effect (and there are still more to come) while internal devaluation will need to continue at a rapid pace (see our recent briefing here for more info on this).

So, plenty of issues already, with what seems to be a fairly unconvincing budget given the state of the Spanish economy. 

One final point to note is that Spanish Economy Minister Luis De Guindos kept insisting that the measures were all in line with recommendations from the EU/IMF/ECB troika or in some cases even went further. This looks to be leading into a Spanish reform programme as part of a bailout/bond buying scheme, hinting that Spain may be preparing that request after all.

The budget which austerity can't touch?

Amongst all the hustle and bustle of the budget, there's always the interesting side-story of how much, exactly, UK taxpayers contributed to the EU.

Combing through the latest figures released by the OBR today (yes, we're talking the very fine print, which only people with some sort of obsession look at), we noticed a massive discrepancy for the UK’s net contribution to the EU, compared to the figures produced in the pre-budget report back in November.

In fact, the estimate for 2010-11 increased by £1.1bn (13.6%) compared to what the UK government budgeted for in November, while the estimate for 2011-12 increased by £1.8bn (26%). Some of this is expected to be recouped over the following two years with lower contributions but overall the forecasts for the UK net contribution up to 2014 have increased by £1.8bn.

The table below sets out the new estimated net contributions to the EU budget (see here and here to compare the original tables):





Not a sum to be sniffed at given the savings which the government is looking to make and the overall amounts involved here.

So why were the forecasts from only four months ago so far off?

The OBR and Treasury reports from today provide little insight on this front. The main change comes from a fall in the public sector funds which the UK receives from the EU (e.g. farm subsidies and regional spending). Since this falls and the gross contributions stays roughly the same, on net the UK is contributing more.

Why have these funds fallen so suddenly?

Again, it’s difficult to say, but it seems strange given that all the EU spending has been negotiated and laid out well in advance. One reason could be that the UK government decided to shelve some projects which involved ‘co-financing’, where the government has to fund part of the project (between 25% - 50%) to release the EU funding for the rest of it. The government may have reduced such projects to reduce its spending, which would have resulted in it accessing a lower amount of EU funds. It also seems strange to us that the UK rebate did not adjust for this (or has not been forecast to) since part of its calculation relies on how much the UK actually gets back from the EU budget.

This also goes to show the perverse incentives inherent in the EU budget, where national governments have to spend money to unlock the funding (under co-financing) - or see the funds cancelled. Though there's an opportunity to recoup some of the cash further down the road, it puts any government that is trying to cut its deficit in a very difficult position. One way or another, it'll lose out.

In any case, it is more than a little concerning that the forecasts were so substantially wrong only a few months ago (particularly since the 2010-11 budget year had already finished by that point).

The EU budget contribution is clearly not the biggest or most important item on today's agenda - but it's definitely not becoming any better value for taxpayers' money.

Has Osborne taken a crash course in Portuguese accounting?

Has the Treasury been taking some accounting tips from Portugal? One would hope not given Lisbon's current predicament.

But an interesting story has surfaced ahead of the UK government’s budget announcement. Apparently, the UK government is taking over the Royal Mail pension funds, transferring its assets and liabilities onto the government balance sheet.

Now, we don't have a dog in this fight, but there's an interesting EU angle here, which we suspect few people have spotted. In fact, the episode instantly reminded us of the situation we have seen in Portugal over the past two years, where one off transfers from pension funds have allowed the government to meet its deficit targets (see here and here). Essentially, the assets move onto the government’s balance sheet and can be sold to raise money (or just held for accounting purposes). However, the liabilities which are ‘contingent’, since they fall well into the future, do not appear in the standard calculations of government debt. This means that, magically, public finances get a sudden boost (allowing the government to increase spending or cut the deficit further). Unfortunately, the downside for taxpayers is that they will now be liable for these future pension pay-outs. As ever, there's no such thing as a free lunch.

Not exactly good accounting, and, as others have pointed out, something which no EU government would let a private company get away with.

This isn't a huge deal, but it's interesting that the IMF and the EU team - and therefore indirectly the UK - which bailed out Portugal, didn’t seem all too happy with Portugal for taking such unusual one-off measures. The latest EU/IMF/ECB troika report notes that such measures do not constitute part of the “structural consolidation” and should be seen as exceptional.

To be fair to the government, it hasn't yet said how this money will be used. It will be interesting to see if it goes towards meeting deficit targets, funding a tax cut or any other budget adjustments. One thing to keep in mind though is that this is a one-off boost, if its used to cover a permanent cut in revenue or increase in expenditure there will be a new hole to fill in the budget next year.

In any case, since Portugal is likely to need a second bailout as some point soon, we hope that this isn't a bad omen for the UK economy...

Hollande takes on London

“I am not dangerous” said a grinning Francois Hollande as he arrived in London yesterday.

The Socialist frontrunner to the presidency is on a damage-control trip following a series of statements on markets and wealth creation. The self-described “Mr Normal” has sought to win over the French electorate by presenting himself as the humble antidote to flashy Nicolas Sarkozy.

Trouble is, Sarkozy is playing the same game. Two weeks ago the incumbent President proclaimed himself the “candidate of the people” and vowed to defend French interests against markets by introducing a Financial Transaction Tax.Hollande, perhaps sensing that Sarkozy is treading on his home turf, has upped his rhetoric.

On Monday night, he denounced the “indecent wealth” of French CEOs, and proposed the introduction of an eye-watering 75% tax rate on annual salaries above €1million. The announcement came in the middle of an unrelated debate on unemployment, prompting accusations of improvisation. Sarkozy claimed that the statement smacked of “amateurism”, while Budget Minister Valerie Pecresse denounced Hollande’s “fiscal inflation”, pointing out that “he invents a new tax every week, without proposing any budget savings”. Hollande has a record of market and wealth-bashing. The Correze deputy stated, twice, that he “didn’t like rich people” in 2007, and announced at his official campaign rally two months ago that his “real enemy was finance”.

On Wednesday, he sought to make amends and soothe market and City of London fears. At a meeting with Ed Miliband he pointed out that “the Left was in power for 15 years [under Mitterrand] during which we liberalised the economy and opened markets to finance and privatisation. There is nothing to fear”.

Is that true?

Well, tellingly, Hollande did not meet one City representative during his time in London.

The 75% tax rate is just the latest in a string a proposals designed to hit the richest hardest. Le Monde estimates that under Hollande’s programme, wealthy citizens would pay almost €12bn in tax. Alongside the 75% rate, which will hit between 15,000 and 20,000 households, Hollande calls for a €10,000 limit on tax relief, a hike in inheritance tax, and a 45% tax rate on incomes above €150,000. The 75% rate outstrips current EU tax levels, the highest of which is 56.5% in Sweden. Frightening French CEOs is unlikely to encourage investment, and fuels fears of an exodus of wealthy French nationals. As Nicolas Sarkozy warned this morning on French radio, “the rich will have no reason left to stay”.

Aside from the domestic political considerations, the move also raises serious questions about the viability of tax harmonisation within the eurozone, something the current French and German governments are pushing for in an effort to improve competitiveness through economic policy convergence. Although the initial proposals focus on corporation rather than personal tax, it is difficult to see how such disparate rates of top personal tax rates would not affect countries' competitiveness within the eurozone.

Hollande’s shift to the Left puts him at odds with other European leaders. Cameron and Merkel have snubbed him, while Miliband’s endorsement was lukewarm. Although Hollande stated that “we need Great Britain to take part in Europe and the adventure of construction”, and argued that “European progressives need to secure the success of the next generation”, Miliband stressed that he would not seek to increase tax rates on the highest earners, or introduce a financial transaction tax. Meanwhile, German Social Democrats have distanced themselves from the 75% tax rate. More than 500 UK business leaders called on George Osborne to cut the "damaging" top tax rate today.

European heads of government will hardly be reassured by the Socialist Party’s recent prevarication over the ratification of the EU’s permanent bailout fund, the European Stability Mechanism. The party’s refusal to endorse the fund (20 deputies voted against, many others abstained) is seen in Europe as illustrative of the Socialists’ unpredictable policy-making. Hollande’s oft-repeated pledge to renegotiate the fiscal treaty does not inspire much confidence in Brussels either. As a high-ranking Brussels official told Le Monde two days ago “nobody really knows what Hollande stands for”.

Either way, Hollande's off the cuff announcement marks another twist and turn in what is becoming a fascinating contest with significant repercussions not only for France, but Europe as a whole.

Sarkozy: a Tobin Tax is an "absurdity"

In a debate with Francois Hollande and François Bayrou, a youthful Nicolas Sarkozy calls the Tobin Tax an “absurdity”. You heard that right. Sarkozy - who recently announced his plan to introduce a Financial Transaction Tax(FTT) by the 1st of August “with or without the others” - warns in a 1999 TV debate of the dangers of excessive financial regulation.

In particular, he argues:

“If we tax, none of the other countries will do so,” adding that “penalising wealth creation in our country will only serve to benefit wealth creation elsewhere, unemployment for us and jobs for the others”.

He’s clearly changed his mind.

EU-tax back on the agenda

Today's FT Deutschland splash reveals that EU Budget Commissioner Janusz Lewandowski will in September table different options for introducing an EU tax to fund the bloc's budget. Apparently, Mr. Lewandowski believes that the current drive in Europe to cut spending is making governments more receptive to the idea of a single tax.

He said,

Many countries want to be unburdened. In this way, the door has been opened to think about revenues that are not claimed by finance ministers...If the EU had more of its own revenues, then transfers from national budgets could be reduced. I hear from several capitals, including important ones like Berlin, that they would like to reduce their contribution.

The thinking is that if the Commission raised its own taxes, then the burden on member states' budgets would be reduced, and member states would pay 'less' to the EU.

This logic is of course fundamentally twisted as the burden on taxpayers - which surely is what matters in the end - would be exactly the same. Only thing that would change is the layer of government that raises the taxes. The Commission is effectively trying to play on governments' desire to be seen as cutting spending as a pretext to concentrate taxation powers in Brussels. The views of taxpayers - the folks who will actually pay for this - are simply ignored.

Pretty disingenuous.

According to Lewandowski, possible sources of an EU tax include a financial transaction tax, levies involving the Emissions Trading Scheme and/or a levy on air travel. EUobserver reports that the Commission hopes that a deal on an EU-tax can be reached during the Danish Presidency in 2012.

Unsurprisingly, Lewandowski's comments have already provoked pretty strong reactions, with German Finance Ministry spokesman Tobias Romeis telling reporters in Berlin that, "Calls to introduce an EU-tax are in opposition to the position the government established in its coalition treaty, in which it says that we will deny an EU tax or EU involvement in national taxes."

So the German coalition government says it will oppose an EU tax, but what about the British one?

This would seem like an obvious one for the Coalition to squash given that it represents a massive step towards a federal Europe. But you can also see the temptation.

A direct EU tax on, say, financial transactions or travel is easier to 'hide' than a line in the annual budget. The problem is that the UK's contribution to the EU is going up all the time - despite the almost universal belief in Britain that the EU budget is exceptionally poor value for taxpayers' money. The UK's net contribution is projected to rise to £10.3 billion in 2014/15 (according to the Coalition's June budget), meaning that in a decade, the UK's net contribution has increased by around 230%.


This continuous increase has become a bi-annual embarrassment, which any UK government would like to put an end to (particularly when everyone is talking austerity). Creating an arrangement under which the UK's EU contribution actually doesn't show up in the budget would do the trick.

In the end, though, it's very unlikely that the Coalition would be able to pull it off even if it wanted to - particularly as it has to get around its pledge to hold a referendum on transferring powers to the EU. And let's remember, most of Cameron's Cabinet genuinely don't want an EU-tax for a range of reasons, including ones relating to ideology and democracy.

This debate will most certainly drag on.

tax cooperation

There are a bunch of interesting things in the Treasury's review of the internal market (which comes ahead of the Commission's own review in March).

What exactly is this passage on tax "cooperation" about?

Looking ahead, in an increasingly global economy, no country will be able to set its tax policy in isolation from other countries and so cooperation between countries in the EU and elsewhere will important in ensuring that national tax systems can coexist effectively. This will involve continuously working together to drive down costs to business, improve transparency, exchange information and tackle fraud. The key is to preserve national flexibility, while strengthening the effective cooperation between Member States, rather than creating rigid structures incapable of adapting to the evolving demands of globalisation.

It's certainly a change from Gordon Brown's previous attitude to tax coordination (i.e. "no, no, no"). Presumably they are trying to play nice because they need the Commission's permission to take action on VAT carousel fraud.