Friday, March 12, 2010

This is not Progress: Transaction Taxes

There have been many calls for a transaction tax. I oppose all of them. I am not a free-market fundamentalist, but intervention here will help nobody. I understand the desire to tax speculator's trading activities, they can often be seen as value extracting instead of value creating activities, but at the end of the day, they do add liquidity and lead to tighter spreads, even if the liquidity is of low quality. The problem here is regulatory arbitrage, the transaction tax can easily be circumvented by moving transactions off-shore. I understand that is not trivial, but all the large  operations, the ones that can really affect the financial system, are big enough to be able to move the taxable operations because the cost of moving the operation will be less than the cost of paying the tax. Meanwhile, all the smaller players will be stuck paying the tax.

There is a lot of legitimate transactions that would end up burdened by the tax, from a small airline hedging fuel costs to a farming operation locking-in a price on a harvest, to a municipal water company hedging their energy costs (you'd be surprised at how much electricity those pumps need). The media has called it a "Robin Hood" tax and the politicians are throwing numbers like "0.25 percent" around. They just don't get it. First of all, this would mean bye-bye to the money market mutual fund industry and it's associated returns for holders of cash. Secondly, it would wreak havoc in the Fx markets and inevitably lead small money-changers to go into the black market since the tax would be bigger than the current bid-ask spreads. Finally, the tax would just end up being paid by consumers in the form of higher prices. I won't even touch the subject of market makers, whether official or de facto.
We need to fix problems, not symptoms! This is not progress.


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