Appendix: Impact of a Transactions Tax on Share Prices and the Cost of Capital
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The author is indebted to Franklin Allen, Julian Alworth, Alan Auerbach, Isaias Coelho, Carlo Cottarelli, Randall Dodd, Timothy Edgar, Douglas Gale, David Hillman, Michael Keen, Albert Kyle, Victoria Perry, Stephan Schulmeister, session participants at the National Tax Association Spring Symposium 2010, representatives of civil society, and the many individuals who posted their views on the topic on the IMF website, for their comments and insights.
For a discussion of pecuniary and non-pecuniary foreign exchange controls, see Arivoshi, and others (2000).
Argentina has provincial STTs.
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.
The SEC resets the fee rate semiannually to meet a revenue target.
European Council Directive 85/303/EEC.
Explicit taxes on foreign exchange can perform a similar role to implicit taxation in the form of capital controls, though the latter are not considered here. For a recent analysis of foreign exchange controls, see Ostry and others (2010).
Japan collected 0.55 percent of GDP in securities transaction taxes at the peak of its stock market bubble in 1988 (OECD Revenue Statistics).
Kiefer (1990) notes that, because institutional investors generally face lower non-tax transaction costs than retail investors, an STT will reduce institutional trading more than retail trading.
Imposition of an STT can have varying effects on liquidity in markets with asymmetrical information. Subrahmanyam finds that introducing a transactions tax reduces liquidity in oligopolistic markets, since it causes Cournot-competitive traders to scale back their trading; however, in the presence of a monopolist market maker, introduction of an STT may not decrease liquidity, and may even raise it if the monopolist market maker has information that other traders lack, because the tax effectively reduces the information asymmetry in the market. Similarly, Dupont and Lee find that in a market with informed and liquidity traders, an STT may increase liquidity by driving informed traders out of the market.
Schmidt’s measure of transaction costs is the bid-ask spread, Since this is endogenous to trading volume (higher turnover usually lowers bid-ask spreads due to lower liquidity and inventory risk), Schmidt estimates a two-stage least squares using external trade as an instrument for trading volume in the bid-ask spread equation.
These statistics measure derivatives by their notional amounts, which can greatly overstate net exposures.
Examples of this in the U.S. stock market include the October 1987 crash attributed to “program trading” and the May 2010 “flash crash.”
Kupiecs (1996) also distinguishes between short-term price volatility and return volatility; he demonstrates that, while introduction of an STT may lower price volatility, by reducing asset prices it unambiguously increases return volatility, which is of greater concern to investors.
In De Long, and others (1990a), it is the interaction between uninformed noise traders and informed traders that destabilizes prices: Informed traders, anticipating a rise in demand from noise traders, buy the asset to sell to noise traders at a price in excess of fundamental value.
An exception to this is Green, and others (2000), which attempts to decompose volatility into market, fundamental, and excess volatility. They find that the U.K. 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.
Dow theory, one of the earliest forms of technical analysis, was developed during the 19th century, when transaction costs were substantially higher. A basic tenet of technical analysis is that price formations that develop over longer periods predict future price movements more powerfully than short-term price formations (Murphy, 1986).
Analogously, Kirilenko and Summers (2003) show that the deadweight loss from a BTT is less significant in Brazil than elsewhere in Latin America, which they attribute to its more highly developed financial system.
This discussion, which is analogous to the effect of the corporate income tax on corporate and non-corporate capital found in Harberger (1962), is adapted from Kiefer (1990).
For a discussion of the incidence of capital income taxes on workers vs. capital owners, see for example Randolph (2006) and Hassett and Mathur (2006).
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.
If the cost of an STT is capitalized into securities values, then the value of those securities’ derivatives will be reduced. However, this does not mean that derivatives can be exempted from taxation with no effect. Taxing only the spot market will drive trading into untaxed derivatives markets, lowering the capitalized discount of the tax in the spot market. In the extreme, except for initial issuance of securities (which may be exempt under the STT), all trading would take place in derivatives markets; the capitalized discount of the STT would be zero; and the tax would collect no revenue and have no impact on securities prices.
In 2009, CFDs accounted for 40 percent of trading on the London Stock Exchange (City Credit Capital, 2010).
The premium may be a small fraction of the spot price for an out-of-the-money option. For a call option, the premium varies negatively with the strike price, while the reverse is true for a put option. If an option matures out-of-the-money, it is not executed and the strike price is never paid.
In recognition of this, the Obama administration has set a goal of encouraging more derivatives to become exchange-traded (U.S. Treasury, 2009).
Taxation of unit trusts under the U.K. stamp duty is subject to certain restrictions. HM Treasury (2010).
The Swiss transactions tax shares this structure.
A separate paper is planned on administrative aspects of FTTs.
Since 1981, the New York State tax, which was enacted in 1905, has been subject to full rebate upon application.
Revenue figures are for Stamp Duty on shares only, i.e., they do not include revenue from real estate transactions.
In a clearance service account, investors buy and sell rights to shares owned by and registered to a third party financial institution; purchase and sale of these rights therefore does not by itself trigger stamp duty.