A rich-to-poor Robin Hood tax may sound good, but is it?

'Yes!' say France and Germany. It's a 'terrible idea', cry the City sheriffs. Laura Chesters looks at the divisive financial transaction tax, and its implications for the UK

Robin Hood tax, Tobin tax, fat tax. Call it what you will, what's important is that the proposed levy on the City has the support of such high-profile characters as the Archbishop of Canterbury, Bill Gates and Love Actually star Bill Nighy.

Proposals from Brussels, backed by France and Germany, are pushing for what it calls a financial transaction tax (FTT) to be introduced worldwide by 2014. Leading continental politicians believe that they could raise around €57bn (£49bn) a year by taxing financial deals, which could then be passed on to the needy in the developing world or in Europe.

However, the UK is split over this plan to take from the rich to feed the poor. Bankers and business folk in the Square Mile believe the plan would end in hundreds of companies leaving the UK. Opposing them is the Robin Hood tax campaign, which boasts more than 250,000 Facebook friends.

The idea of a FTT isn't new. The nickname Tobin tax came from the Nobel economist James Tobin, who first formulated it in 1978. The levy has been tried in Sweden, where it was a resounding failure (see box).

The tax sees a fraction of a percentage taken from each financial transaction, from hedging contracts to currency exchange. A thousand economists, backed by Microsoft's founder Gates, agree that the tax can only be beneficial and that such a tiny levy could not possibly hurt the banks – particularly at a time when the likes of Barclays are showing improved profits.

David Hillman, spokesman for the Robin Hood tax campaign, argues: "With the G20 and most of Europe working towards a financial transaction tax, our government needs to stop blocking and put the needs of the public ahead of special interests in the City."

Actor Nighy travelled to Cannes last week to lobby the G20 summit to support the tax, while the Vatican and Oxfam have added their weight to the campaign. However, George Osborne, the Chancellor, believes the Robin Hood tax will simply rob the British economy, leading to lower output and therefore less investment and increased unemployment, and he shows no sign of changing his mind.

The Chancellor has pledged to veto the plan unless it secures the support of all the world's major financial centres, including Wall Street. He and critics claim that if the tax is just Europe-wide, big UK companies and banks will flee to international centres with lighter regulation, such as Hong Kong.

A recent report from accountant BDO states: "If the tax is limited to the EU, rather than implemented globally, it could push market liquidity, business and related jobs to countries that do not impose such a tax."

The French president, Nicolas Sarkozy, and the German Chancellor, Angela Merkel, continue to advocate the FTT. The reality is that a shift in the financial sector away from the EU will not hurt their domestic economies – unlike in the UK, where four out of five of Europe's financial transactions take place.

Louise Cooper, markets analyst at the broker BGC Partners, says: "The tax is a terrible idea. It is imposed on us by France and Germany who would love to see London suffer. It's purely a political move. The US will never introduce it and all it will do is drive business from London. If the tax is introduced, the money taken in tax will hit pension funds and force banks to put up charges for the consumers."

Andrew Tyrie, chairman of the Treasury Select Committee, last week wrote to the Chancellor to clarify what steps are being taken to protect the UK from the plans. There are rumours the FTT could be introduced as a form of VAT – a duty, not a tax – which would therefore sidestep the need for unanimous approval across the EU.

Tyrie has identified 17 problems with the tax, including a fall in UK tax revenues caused by the migration of big business from London. This summer, Michael Spencer, the chief executive at Icap, the broker, told The Independent on Sunday: "This tax would destroy the City and cost the Exchequer billions, but it would benefit Brussels. Companies like Icap will simply move elsewhere, outside the EU, if Nicolas Sarkozy and Angela Merkel push ahead with this silly tax."

The Adam Smith Institute conducted research during the summer which found the proposal of an FTT would drive a significant proportion of the financial sector out of the UK. Dr Neil Bentley, deputy director-general of the CBI, argues that a FTT is a "crude instrument" that would increase the cost of capital for businesses, holding back their expansion plans.

He adds: "The European Commission's decision to press ahead with [an] FTT is completely misguided at a time when it's clear that Europe needs a relentless focus on growth."

Opponents of the tax are also critical of some of the thinking underpinning the idea. For example, the Robin Hood campaign claims that banks would be put off making speculative transactions. These have tiny profit margins, so even a marginal tax of, say, 0.05 per cent on these transactions would reduce the appetite for such risky deals, they argue.

Jon Peace, a banking analyst at Nomura, concedes that the imposition of even a low rate on "high-frequency traded securities", such as currencies and futures, would reduce trading volumes "dramatically". However, he counters that this would do little to take risk out of the banking system: "We find no convincing evidence that FTTs lower short-term price volatility and high transaction costs are likely to increase [volatility]. Asset bubbles are driven more by high leverage than by excessive transactions."

The Pope and Oxfam, meanwhile, are convinced that the tax will raise money for the poor in the developing world. Bill Dodwell, head of tax policy at Deloitte, sighs: "Supporters of the tax have focused on the principle rather than the detail of it. The EU has absolutely no intention of sending any money raised to the developing world. It will be swallowed up by the need of the EU budget."

Andrew Murray, partner at the City law firm Bargate Murray, points out that it is all too easy to criticise the campaign and its supporters for a lack of a grasp on the impact on business. However, the business world should understand that, according to recent polls, the Robin Hood tax does have the support of two-thirds of Britons.

"The Archbishop of Canterbury is an erudite theologian, but not an economist," says Murray. "It would be all too easy to criticise Rowan Williams for not having prepared an impact analysis study to demonstrate how the Tobin tax could, or perhaps should, be implemented. He is venturing into the realm of politics because he believes he is morally correct in so doing."

The Archbishop has probably read the political mood correctly, with Sarkozy pushing his idea for the FTT at the G20 last week, and Robin Hood's band of merry men seemingly growing daily. But, in this case, taking from the rich could end up making the British economy much poorer.

Swedish Trials

The perfect sponge? Tax recipe needs tweaks

Many detractors of the financial transaction tax point to a disastrous attempt by Sweden in 1984 that led to half of its trades moving to London by the turn of the decade. The Adam Smith Institute report into the Tobin tax found that 60 per cent of trading volume of the 11 most actively traded Swedish shares migrated to London while Sweden had the levy in place.

The tax raised only a 30th of the proceeds predicted by its supporters, and was scrapped after just five years.

But supporters of the tax say the flaws of the Swedish trial could be tweaked to ensure the same mistakes are not made again. The campaign's website says: "It's a bit like making a sponge cake without any raising agent. It won't work, but that doesn't mean that the idea of a sponge is a bad one. Simply by changing the recipe slightly, you could have the perfect sponge."