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Security transaction taxes: issues and evidence

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Abstract

In reaction to the financial crisis, increased attention has recently been given to security transaction taxes (STTs) as a means of (1) raising revenue for a variety of possible purposes and/or (2) helping to curb financial market excesses. This paper reviews existing theory and evidence on the efficacy of an STT in fulfilling those tasks, on its potential impact, and on key issues to be faced in designing taxes of this kind.

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Notes

  1. Argentina has provincial STTs.

  2. The Indian securities transaction tax was introduced in 2004 as replacement for India’s unsuccessful capital gains tax. Japan also has an optional 1 percent transactions tax on stock sales, which investors may elect in lieu of paying a 10–20 percent capital gains tax.

  3. European Council Directive 85/303/EEC.

  4. This policy appears to conflict with the EC’s 2011 proposal for an STT on secondary market trades, which, like a capital levy, would have the effect of increasing the cost of capital for firms issuing new shares or bonds.

  5. Japan collected 0.55 percent of GDP in securities transaction taxes at the peak of its stock market bubble in 1988 (OECD Revenue Statistics).

  6. SIFMA data (http://www.sifma.org/research) indicate that the average holding period for corporate bonds in 2009 was 1.6 years.

  7. Input-output tables, US Department of Commerce: www.bea.gov.

  8. Subrahmanyam (1998) and Dupont and Lee (2007) present models showing that, in the presence of asymmetrical information, the impact of an STT on liquidity may be either positive or negative, depending on market microstructure.

  9. Xu (2010) notes that exchange rates, though they represent the relative prices of traded goods and services, also reflect the prices of financial assets, and thus behave to a large extent like securities market prices, with similar patterns of volatility including bubbles and crashes.

  10. An exception to this is Green et al. (2000), which attempts to decompose volatility into market, fundamental, and excess volatility. They find that the UK stamp duty positively affects market and excess volatility, but negatively affects fundamental volatility. However, their proxy for fundamental volatility, the short-term risk-free interest rate, is somewhat unconvincing. Short-term government rates are largely driven by the central banking system rather than stock market investors, and increases in stock transaction taxes may drive liquidity into the fixed-income market, thereby increasing liquidity and reducing short-term interest rate volatility.

  11. In 2009, algorithm trading accounted for at least 60 percent of US equity trading volume and 30–40 percent of European and Japanese equity trading; it also accounted for 10–20 percent of foreign exchange trading volume, 20 percent of US options volume, and 40 percent of US futures volume (Reuters 2009). Growth of exchange-traded derivatives has outstripped spot market activity (Schulmeister et al. 2008).

  12. Barber and Odean (2000) show that retail investors generally lower their returns through excessive trading.

  13. Kiefer (1990). The solution proposed in proposed legislation for a US STT was to tax both trades in mutual fund shares and mutual funds’ own trades at half the general statutory rate.

  14. The comparison here is to an “ideal” income tax that taxes capital gains on a mark-to-market basis with full loss offset. The complications introduced by a realization-based capital gains tax are discussed below.

  15. Stiglitz (1969).

  16. Poddar (2007). Application of VAT to trading/market-making, which is compensated through the bid–ask spread commingled with capital gains, remains problematic.

  17. Taxation of interest at the investor level would correspondingly be eliminated, though this reform generally results in a revenue increase due to the presence of tax-exempt and foreign investors.

  18. The US Securities Exchange Commission has moved to ban flash trading, the practice of permitting select traders a split-second preview of incoming orders before such information becomes available to the general market. See: http://www.sec.gov/news/press/2009/2009-201-factsheet.htm.

  19. In theory, swaps should even be taxed twice on their notional value, since they represent offsetting long and short positions in the referenced asset. Taxation of swaps presents a unique enforcement challenge: Since no principle changes hands, the notional principle could be divided by an arbitrarily large factor and all payments multiplied by the same factor, leaving the cash flows of the instrument unchanged but shrinking the size of the tax base. Anti-avoidance language should therefore specify that if swap cash flows are multiplied by a factor, the notional principle on which the tax is based should also be multiplied by the same factor.

  20. Since 1981, the New York State tax, which was enacted in 1905, has been subject to full rebate upon application.

  21. Schulmeister et al. (2008).

  22. Oxera (2006). Transaction costs for high-frequency trading are reportedly much lower, though public data on HFT spreads are not currently available.

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Acknowledgements

This paper has greatly benefitted from comments by Carlo Cottarelli, Michael Keen, Victoria Perry, John Brondolo and other attendants at IMF seminars, Alan Auerbach, Timothy Edgar and other participants at the National Tax Association Spring Seminar, and numerous civil society organizations.

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    Thornton Matheson

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Matheson, T. Security transaction taxes: issues and evidence. Int Tax Public Finance 19, 884–912 (2012). https://doi.org/10.1007/s10797-012-9212-5

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