Advocating Tax On Stock Trading

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Stiglitz championed the transaction-tax idea in 1989. He was only slightly less apologetic, lest the profession fear for his sanity. “As an economist, I begin with a general suspicion against narrowly based taxes,” he began. But he overcame that reservation, arguing that such a tax would make the stock market more efficient and reduce price volatility. It’s a tax that’s meant to correct behavior, as described by the English economist Arthur Pigou. Why should we tax casino gambling but not options trading?

Such a tax could make the markets better. Financial markets raise capital for new enterprises. They help people exchange assets and information. But just because there is higher volume doesn’t mean these trades are expressing more views. Instead, all that is happening is that the bandwagon is speeding up. The faster it goes, the more people want to get on. Noise traders drive out the fundamental investors. During the tech bubble, famous value investors like Julian Robertson were forced out of the market at the top. “If we think people in the market are looking at what other people are doing, it’s totally plausible that the more people there are, the further you are getting from the right prices,” says Baker.

I won’t pretend that the tax idea is much in vogue today. When I asked Summers about transaction taxes, he replied that he has rethought his position from two decades earlier: “I have become convinced that in the world of today, because of globalization, derivatives, and other institutional changes, it is probably not realistic to collect significant revenue from turnover taxes. I also have become more convinced than I was years ago of the importance of maintaining liquidity.”

If such a levy did get any traction in Washington, the usual suspects would rise with a passel of objections. They would say the tax would stifle innovation and efficiency. But to let those words stand as descriptions of what has been happening in markets lately is to concede the debate. Experimentation would be a better word than innovation to describe what the Wall Street firms have been doing.

Put that way, there are obviously limits to what we should permit the math geniuses to try in the petri dishes of the capital markets. “Financial innovation has been treated almost as an end in and of itself,” says Baker, one of the few economists not to have given up on the transaction tax. “I was always suspicious, but I’m even more so now. These people”—those math geniuses—“had no idea what they were doing.”

Opponents will also argue that a speculation tax will lead to distortions and hurt the U.S.’s position as the leader in global capital markets. But the U.S. isn’t powerless in international negotiations. And London is headed for some measure of greater regulation too. Working in concert, the U.S. and Britain could implement such a tax.

As for Summers’ concern about liquidity, clearly trading has dried up in certain markets in the past year, sending the value of some assets down dramatically. But the cause was short-term thinking at financial firms. They thought they would always have markets to sell into, that the arenas of mortgage securitization or auction-rate securities or structured finance would never disappear. If the markets had been dominated by more diligent, long-term traders, such firms would have had to become more cautious about what they sold.

The crisis in the markets requires some radical rethinking. Of course, no government regulation or tax structure will be able to prevent fraud, greed, stupidity, and short-sightedness. But the prevailing political and economic ideology of the past 25 years has been to discount the propensity of markets to encourage these tendencies. Indeed, proponents have argued that markets prevented such behavior and were marvelously self-healing.

It has become clear that the opposite is true. Markets tend toward excess and run amok if unchecked. A tax that nudges markets toward becoming more rational and less frenzied would be a good start.

And raising revenue for a deficit-­ridden government from people who can afford it would be a nice little bonus.

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