Hey, proponents of securities transaction taxes: If you’re trying to sell them as a white knight that will rescue investors from the evil volatility dragon, you’re selling a bill of goods you can’t deliver.
The issue of STTs – taxes imposed on every trade of a security in a given market – has arisen again in the midst of Europe’s debt crisis. The supporters of the idea argue that STTs discourage high-speed, high-volume trading by speculators – the type of trading that heightens volatility and can seriously distort a market (like, say, the one for Italian bonds) and seriously spook investors, quickly turning a problem into a crisis.
Oh, yeah, and STTs are also a great way to raise a lot of tax money.
The raising-money part would work. The slaying-volatility part? Not so much.
A new Bank of Canada study looked at stock-market data surrounding nine changes to the old New York State Security Transaction Taxes between 1932 and 1981, when the tax was phased out. It’s the first study of the market impact of U.S.-imposed taxes on securities transactions – made doubly relevant because the taxes were imposed on trades on the New York Stock Exchange, the biggest equity market in the world, and at varying levels over a lengthy time period.
Their conclusion? “We find no significant relationship between an STT and volatility,” the authors wrote.
What they did find was that STTs reduce trading volume and heighten the price impact of trades (i.e. each trade has a bigger effect on the price change). “Taken together, we find that an STT harms market quality.”
There has long been a theoretical disagreement about the relationship between volatility and securities transaction taxes (often referred to as “Tobin taxes,” after Nobel prize-winning economist James Tobin, who in 1971 proposed taxing foreign-exchange transactions). On the one hand, such a tax may discourage rapid in-and-out, short-and-long trading of speculators, which is often blamed for fuelling volatility. On the other hand, lower trade volumes reduce market liquidity and increase the price impact of each trade – which would increase volatility.
The Bank of Canada study found, essentially, that neither is the case. That’s consistent with a working paper commissioned by the International Monetary Fund this year, which conducted a wide-ranging review of research into the effects of actual transaction taxes in various jurisdictions.
While it found that transaction taxes do reduce trading volumes and liquidity, and discourage risk-taking (to the detriment of prices of risk assets such as equities), it concluded that no consistent relationship has emerged between transaction taxes and volatility. Most studies have found a “neutral” effect, at least in the short term; some found that higher transaction taxes have increased volatility.
The IMF has been looking into financial transaction taxes for a couple of years now, after the G20 leaders directed it to examine various options “as to how the financial sector could make a fair and substantial contribution toward paying for any burdens associated with government interventions to repair the banking system.” And, indeed, the IMF working paper did agree that a transaction tax would be a great way of raising money. (Though it ultimately concluded that their potential market-distorting effects outweigh this benefit.)
A 2008 study by Austrian economist Stephan Schulmeister estimated that such a tax on global stock, bond and derivatives trades would generate more than $200-billion (U.S.) in annual revenues. That scale of rainy-day fund could come in very handy in a financial crisis – or help indebted nations clean up fiscal houses that became very messy while governments were funding massive stimulus packages to avert a near-depression a couple of years ago.
If that’s the point of taxing financial transactions, fair enough; excesses of financial-market participants can expose government institutions to peril, so maybe those participants should be asked to front the money, through transaction taxes, to pay for their own eventual bailouts and help offset the cost of managing the consequent economic fallout.
But let’s call a tax a tax – instead of trying to dress it up as a virtuous regulatory tool to rid markets of excess volatility for the greater good. The mounting evidence simply doesn’t support it.