* New plan would impose much smaller levy on shares from 2014
* Revised tax could raise only one tenth of original target
* Levy may be rolled out only later on bonds, derivatives
* Banks opposed levy, London taking legal action
By John O'Donnell and Ilona Wissenbach
BRUSSELS, May 30 (Reuters) - European countries plan to scale back a proposed financial transactions tax drastically, initially imposing a tiny charge on share deals only and taking much longer than originally intended to achieve a full roll-out.
While yet to be formally proposed, the sweeping revisions would mark a victory for banks and trading organisations which have lobbied furiously against a scheme aimed at making them contribute to the costs of the financial crisis.
But the move also reflects big practical problems in collecting the revenue and political divisions over the tax, which has encountered legal challenges from London and caused concern even among the 11 euro zone countries backing it.
A redesigned levy would raise only about one tenth of what was once targeted, officials who have worked on the matter told Reuters, removing the claws from a proposal initially championed by Germany and France.
"The whole thing will have to be changed quite a lot," said one of the officials, who has closely followed negotiations over the levy, agreed last October and drafted by the European Commission. "It is not going to survive in its current form."
Resurrecting an idea first conceived by U.S. economist James Tobin more than 40 years ago was symbolically important in showing that politicians, who fumbled their way through the crisis, were tackling the banks blamed for causing it.
Officials in Brussels had expected the financial transactions tax (FTT) to raise up to 35 billion euros ($45 billion) a year. But under the latest model, the standard rate for trading bonds and shares could drop to just 0.01 percent of the value of a deal, from 0.1 percent in the original blueprint drafted by Brussels.
That would cut income to roughly 3.5 billion euros or less, said one senior EU official. The tax may now also be introduced more gradually. Rather than levying trades in stocks, bonds and some derivatives from 2014, it may now apply to shares only next year and to bonds up to two years later.
Derivatives may be covered after that, or the roll-out could be halted altogether if problems arise, such as if traders move their deals en masse elsewhere to avoid the charge.
"You can introduce it on a staggered basis," said the official. "We start with the lowest rate of tax (0.01 percent) and increase it bit by bit."
Any final decision is up to the countries that have signed up and remains months away. Germany, for example, is unlikely to back any scaling down of the levy in public before elections in September, because Chancellor Angela Merkel's coalition has committed itself to the voter-friendly tax.
"There is a lot of technical work to be done still on the proposal," said a spokeswoman for Algirdas Semeta, the European commissioner in charge of tax policy. "Depending on the speed of progress from here, it is still feasible that the common FTT could be implemented in 2014, although January 2014 is looking less likely."
Seven months ago, Germany, France and nine other countries - Italy, Spain, Austria, Portugal, Belgium, Estonia, Greece, Slovakia and Slovenia - agreed to press ahead with the levy, having failed to persuade all 27 EU member states to sign up.
Some cash-strapped countries have already begun counting on the new income, a welcome windfall when shrinking economies and rising unemployment are sapping tax revenue. But in a world where billions of euros can be moved at the stroke of a finger, even the tax's backers are getting cold feet.
One euro zone ambassador involved in discussions among countries on the proposal said early enthusiasm was waning as governments became aware of the potential pitfalls. "If one thing is clear, it's that the financial transactions tax is not going to fly as far as originally hoped," he said.
Those sentiments are echoed by Daniel Gros, the head of the Centre for European Policy Studies, a Brussels think-tank. "As it is designed right now, it doesn’t make sense," he said, advocating a more straight-forward sales tax on banks.
Influential participants in the financial markets have also made their concerns clear over the costs and the destabilising effects it could have. "I would be astounded if it passes in its current form," Remco Lenterman, chairman of the FIA European Principal Traders Association, told Reuters last month.
"I would almost theorise that if they pass and implement it in its current form, they would have to cancel it after a three- to six-month period as markets would become so dysfunctional that you would have to revert back."
As it stands, the tax faces many obstacles, including how it should be collected and whether it should be imposed according to where the buyer or seller is based, or where the traded security is issued.
In the current design, if either the buyer or seller is based in one of the participating countries, the levy can be imposed even if the transaction takes place elsewhere, such as in London. Luxembourg and Britain fear this will hit trading in their financial centres and could lumber them with the task of collecting the levy, despite not being involved.
Even within the group of 11 countries, there is discord. Italy and France have expressed concerns about widening the tax beyond shares to government debt as both believe it could discourage investors from buying their bonds.
Furthermore, it remains unclear how the tax could be levied on the trading of complex derivatives - a market that is valued in the trillions of euros - or how to prevent an exodus of activity to regions that do not impose any such tax.
"The risk is that if you have some countries not participating, you have some shift of business from the countries in the tax to the countries without the tax," said one official, familiar with French government thinking. "This step by step approach can make sense."
(Additional reporting by Luke Baker in Brussels and Swaha Pattanaik in London; editing by David Stamp)
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