The Bank of Canada has released a working paper by Anna Pomeranets and Daniel G. Weaver titled Security Transaction Taxes and Market Quality:
We examine nine changes in the New York State Security Transaction Taxes (STT) between 1932 and 1981. We find that imposing or increasing an STT results in wider bid ask spreads, lower volume, and increased price impact of trades. In contrast to theories of STT imposition as a means to reduce volatility, we find no consistent relationship between the level of an STT and volatility. We examine the propensity of traders to switch trading locations to avoid the tax and find no consistent evidence that they will change locations. We do find evidence to suggest that taxes imposed on the par value of stock will result in corporations managing the par value in the direction of minimizing the impact of the tax on investors.
Section II of the report, “Regulatory History”, give a highly entertaining account of the history of STT with the New York state government attempting to collect as much revenue as it could, with the affected companies, investors and competitors attempting to minimize the figure. A lot of time, and highly skilled time at that, must have been burned up in these games – which is the most insidious effect of a targetted tax.
Similar fun and games have been observed elsewhere, particularly with respect to preferred shares, as discussed on the blog in the post Par Value.
The literature review in section III traces the debate from the beginning:
The earliest proponents of STTs, Keynes (1936) and Tobin (1978), argue that an STT will improve market quality. In particular, Keynes contends that chasing short-term returns, while potentially profitable to specific individuals, is a zero-sum game in terms of economic welfare. Since one investor’s gain is another’s loss and trading utilizes resources, the value-added through trading is negative. As a result, imposing an STT may increase welfare by reducing wasted resources. Second, since trading is speculative by nature, it potentially contributes to financial instability when trades are driven by short-term capital gains and not fundamental information. Keynes argues that an STT will curtail short-term speculation, and thereby reduce wasted resources, market volatility and asset mispricing. Consistent with Keynes, Tobin (1978) proposes a tax on foreign exchange transactions that would make short term currency trading unprofitable. He suggests that a transaction tax would “throw some sand in the wheels of speculation.”
I have a bit of a problem with this. In the first place, speculators help long term investors by providing liquidity when they wish to buy and sell; in the second place, market prices are a very important signal to issuers, who can choose to start new companies or issue additional stock in accordance with the prices. A dramatic (if rather unfortunate) example of this was the Tech Boom of the late 1990’s, in which all kinds of companies were able to get financing thanks to the influence of speculators on the price of Internet stocks. All good things can be taken too far!
After examining the data, the authors conclude (in part):
Our findings largely come down on the side of opponents of the tax who suggest that an STT will harm market quality. Since spreads have been shown to be directly related to a firm’s cost of capital, imposing an STT may hinder economic growth by reducing the present value of projected profits.
[…] Ms. Pomeranets and Daniel G. Weaver which focussed on the historical experience in New York State was reviewed on PrefBlog. […]