Paul L. Caron

Thursday, January 15, 2009

Hurt: Taxing Speculation

Christine Hurt (Illinois) has an interesting post on Taxing Speculation -- responding to the proposal by Dean Baker of the Center for Economic and Policy Research, and recently picked up by Bob Herbert in the New York Times, to impose a .25% financial transaction tax, which would raise $100 billion per year:

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. ...  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 [the proponents] 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.

Update:  See Adam H. Rosenzweig (Washington University), Imperfect Markets and the Hidden Costs of a Modern Income Tax.  (Hat Tip:  Christine Hurt.)

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Doesn't anyone remember the 1990 "luxury tax" imposed on luxury yachts and aircraft?

Seemed like an excellent idea at the time, except no one paid attention to the unintended consequences - wiping out the New England Boat Building Industry.

Someone call Barney Frank and Chris Dodd. They might remember this or if they don't let us start talking about re-instituting that 1990 "luxury tax"

Historical link here ...

Posted by: RM3 Frisker FTN | Jan 15, 2009 12:21:42 PM

"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."

...possibly make them...?

Ms. Hurt, good for you for trying to get at the truth but, good grief, estimate the compounding!
The stock market is a relatively open, transparent market. The financial crisis did not start there. It started with highly leveraged instruments: opaque by design and deliberately traded in an opaque manner.

Until the financial crisis hit, stock-market volatility was low by long-term historical standards. Arguably, part of the reason volatility had declined was that rapid-fire traders identified mispricings and did not give them time to grow. It's not impossible that perverse consequences would ensue from putting such traders out of business.

Posted by: gs | Jan 15, 2009 6:08:03 PM

The other big problem with this is that it reduces the relative transaction cost of high-spread, illiquid investments, which tend to be of much lower quality: . If this passes, we'll see many more penny-stock scams.

Posted by: taxrascal | Jan 18, 2009 9:06:40 PM