The European Commission's proposed Financial Transaction Tax, supported by 11 out of 27 European Union countries, is designed to discourage what it considers socially useless trading activities as well as raise up to €35bn ($47.1bn) a year. But the risks of unintended consequences look high.

First, the tax could end up deterring plenty of socially useful hedging activity, too. For example, the commission's proposed 0.01% tax rate on derivatives transactions may look low, but it is very high relative to current transaction costs. In the case of a one-week euro-dollar foreign-exchange swap with a notional size of €25m, the tax on two eligible participants would be €5,000 on top of a transaction cost of €279, according to consultant Oliver Wyman-or an increase in costs of 18 times. At the very least, the result is likely to be reduced liquidity and therefore higher hedging costs.