David Brooks writes today in the NYT about economist and co-director of the Center for Economic and Policy Research Dean Baker's proposal to create a "financial transactions tax." This tax (the writer suggests .25%) would be assessed on any sale or transfer of stocks, bonds or other financial asset. The columnist does not specify whether the seller or the buyer would pay the tax, but in a Coasian world it does not matter. (Part of the article seems to suggest it would be both -- by hypothesizing that someone would "pay a quarter-percent fee to purchase the asset in the first place and then another quarter percent to sell it." I'm not sure if this was intended or not. If so, then there is a total of a .5% fee every time a security changes hands.) This fee is projected to raise perhaps $100 billion a year.
Of course, a lot of different new taxes would raise a lot of money -- that's what taxes do -- but we should try to anticipate how a tax (or a deduction) would skew behavior, and try to determine whether that is how behavior should be skewed. The unintended consequences of varying tax policies may in fact add to economic troubles or just create new ones. Many have argued that the mortgage tax deduction may have been an accomplice in the housing bubble, so let's be a little careful before we start imposing taxes or subsidizing behavior with deductions.
My first reaction at reading the first part of the article was that if we want the capital markets to be efficient, taxes lead us away from efficiencies. (Remember one of the (false) assumptions of the efficient capital market hypothesis is that there are no transaction costs. When taxes are present, studies show that markets move away from efficiency, and this is why we see "January effects" for certain types of investments and "November effects" for others. Adding a new tax to buying and selling securities seems like it has the tendency to move the market away from efficiency. At this point in time, we want trading, right? The tax would have to be fairly nominal if it is not going to skew behavior. Is .25% nominal enough? Maybe.
Except that Professor Baker and David Brooks want the tax to skew behavior -- speculative behavior. You see, it's the really bad people known as speculators who are ruining our markets, who "bring a manic quality to the markets, who treat it like a casino." Bad speculators trade multiple times a day, so the small fee would add up and possibly make them just calm down and trade slowly, like the rest of us prudent investors. The "beauty" of the tax is that it is a "progressive" tax "that discourages nonproductive activity." Hopefully some tax people will jump in here, but I think of progressive taxes as those that affect people more as income increases. Do we know that day traders or speculators have more income than "buy-and-hold investors"? We like to say that the "buy-and-hold" people come out on top, so then isn't the tax regressive -- taxing the silly speculators who don't understand investing, just like lotteries are regressive taxes on poor people who are bad at math? I guess the speculators we really, really hate are the ones that make money. Bad speculators.
So, the second question is whether speculation really has no utility or even negative utility to the market. Studies are just appearing telling us what happened when short-selling was banned last Fall, so maybe we'll have the answers soon. But regardless of whether you are a speculator, prudent investors need speculators for liquidity, and issuers need the presence of liquidity to be able to sell publicly-traded shares in the first place. If we tax speculators away, then our financial models that assume the ability to sell a particular security at some price may have to be tweaked once the buyers are gone.
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1. Posted by Thomas on January 13, 2009 @ 12:52 | Permalink
I think you mean Bob Herbert, not David Brooks.
2. Posted by BDG on January 14, 2009 @ 10:03 | Permalink
I agree that the Baker idea is silly. But maybe not so silly would be a similarly-structured pegouvian tax on transactions that create systemic risk. Probably we'd want an expert agency to figure out which transactions those were, though, not Congress -- the size of risk externalities probably changes pretty fast.
3. Posted by BDG on January 14, 2009 @ 10:10 | Permalink
Just for the record, I actually do know how too spell Pigou, but it seems my fingers do not. Also, I have seen reputable economists use both "pigovian" and "pigouvian," and would welcome the views of anyone who believes they know which is the more accepted usage.
4. Posted by Taxrascal on January 14, 2009 @ 23:20 | Permalink
One of the hidden problems with this is that it reduces the relative transaction cost of less liquid investments. For example before this tax you might pay something like .25% in commissions and bid/ask spread to own Microsoft stocks, and 10% in the same to own shares of some OTC company; the tax doubles the transaction cost for buying Microsoft stock, and raises the transaction cost of buying the OTC stock by just 2.5%. It's likely that this would make high-spread investments relatively more attractive, putting more money into companies that are (in general) lower quality and more likely to be scams.
5. Posted by looking closely on January 15, 2009 @ 13:36 | Permalink
Strip away the BS and this is just another sales tax. . .in this case a Federal tax on the sale (and purchase) of all securities.
By discouraging trades in general, this tax would discourage individual traders to act as market makers and decrease liquidity, particularly in thinly traded issues (eg like options).
Decreased liquidity is bad for everyone.
There is also no question that by penalizing individual trades with taxes, you'd decrease their number.
Perhaps that't the point, but I fail to see how its in the public's interest to reduce trade volumes. You're not going to end speculation with these punitive measures, just perhaps reduce the number of traders who are successful at it by eroding their margins.
Decreased numbers of individual trades are also going to have all sorts of unanticipated secondary effects. For example, fewer trades mean lower commission revenues for brokerage houses, who are already being squeezed down the lowest penny by extensive competition. I think some of the smaller ones would be driven out of business (or into acquisition) by increased trade taxes, and the other ones might have to increase their fees to compensate for lower volumes.
Would this rule be in effect for American traders only, or all companies traded on American exchanges? In the first case, I could see American traders moving their assets (and maybe themselves) across the border to Canada or elsewhere to avoid these taxes. In the second case, companies that otherwise SHOULD be trading on American exchanges might decide its better for them to have their companies stock trade on foreign exchanges. I don't think the American consumer benefits there.
The gov't already gets the benefit of double- and in some cases triple- taxation from securities in taxing the companies earnings (at the second highest rate in the world), then in taxing capital gains AND dividends.
Enough already.
If individual trading practices are damaging to the market (eg rampant short selling), then target them for specific action. But putting a blanket tax on all trades is just theft.
6. Posted by TJA on January 15, 2009 @ 13:37 | Permalink
Vermont has a tax on flipping properties. They have a significantly higher capital gains rate on properties that you buy and sell within, I think ,five years without improvements. This might make an interesting case study.
7. Posted by Ben_H on January 15, 2009 @ 13:45 | Permalink
We don't really need to speculate (haw haw) about whether an FTT will raise a lot of money or succeed in dampening speculation. We have many examples of such taxes in the real world. Brazil has the CPMF tax (38bps, charged on both sides, but with exceptions for certain financial instruments), Colombia has the "cuatro por mil", the UK has its stamp tax... there's still plenty of speculation in all these places and a robust set of schemes to dodge the tax. Ever wonder why all institutional investors in the UK trade cfd swaps and not shares directly??
8. Posted by Joe Blow on January 15, 2009 @ 14:44 | Permalink
I think we should tax people who speculate on Op-Ed pages. The should pay .05% of the damage their ideas will cause to the economy. In this way we could cut down on risky speculation that ultimately damages our national fiscal health.
9. Posted by willis on January 15, 2009 @ 14:48 | Permalink
I personally think the tax is a great idea. Lets take $100 billion out of the capital market and use it to fund a $100 billion bailout of the capital market. Its sheer genius. Think of the multiplier effect, not to mention the add, subtract, and divider effect.
10. Posted by Doug on January 15, 2009 @ 15:48 | Permalink
What happens when the speculators leave the market and the liquidity dries up
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