Tiny Tax Would Make a Big Difference

August 07, 2012

Dean Baker
The New York Times (Room for Debate), August 7, 2012

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The Knight Capital debacle last week gave us yet another example of the financial system run amok. The company’s computers were apparently misprogrammed. As a result, they caused wild gyrations in the price of several major stocks. This incident naturally brings back memories of the “flash crash” two years ago, when programmed trading sent stock prices plummeting by close to 10 percent for no reason whatsoever. In the era of high-speed trading, it seems that such events are inevitable.

Whatever hardships befall the victims of such occasional mischief, it’s not clear that we should be any happier when the programs are working as planned. After all, many of these programs are designed to pick up large trades and effectively jump in ahead of the trader.

For example, if a major investor or mutual fund was in the process of selling a large amount of G.E. stock, a high-speed program may detect the movement. The high-speed trader could then short G.E. stock and buy it back immediately after the big sale and get a guaranteed profit. This has the same effect on the stock market as insider trading. Insider trading is bad for markets because it means that normal investors will get a smaller share of the gains. The same holds true with the high-speed trading platforms that now dominate the market.

A modest financial speculation tax can go a long way to putting an end to such practices and bringing the markets back to earth. It can also raise large amounts of money. A bill proposed by Senator Tom Harkin and Representative Peter DeFazio would impose a tax of just 0.03 percent on trades. According to the Joint Tax Committee of Congress, it would raise more than $350 billion in its first nine years. A set of taxes more in line with the 0.5 percent tax that the United Kingdom imposes on stock trades could raise more than $1.5 trillion over the next decade.

Even the higher set of taxes would raise the cost of transactions only back to their early 1990s levels. And the United States already had very liquid financial markets by 1990. In short, a financial speculation tax is a great way to raise lots of government revenue by making financial markets better serve their purpose of transferring capital from savers to investors.

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