A Securities Transactions Tax and Capital Market Efficiency

PAUL H. KUPIEC ^*

This paper revisits the debate on the securities transaction tax (STT). The analysis
uses Tobin ( 1984 ) taxonomy of financial market efficiency to examine the potential
effects of such a tax and concludes that a STT probably would not enhance the overall
functioning of financial markets.

Advocates of a securities transactions
tax (STT) believe that financial markets
have become too large and consume too
many resources for the social benefits they
produce (see, for example, Keynes, 1936;
Tobin, 1984; Stiglitz, 1989; Summers and
Summers, 1989). This view may have ap-
peal in part because directly observing the
social benefits that these markets generate
is difficult. The opacity of benefits sharply
contrasts with the transparent rent seeking
that motivates market participants' activ-
ities. It is difficult to argue that society
benefits greatly if a company's share price
reflects new information minutes before it
otherwise might have, and yet enormous
profits reward the first to recognize and
trade on such news. The highly publicized
salaries and profits earned by financial
market participants for seemingly unpro-
ductive "paper" transactions may offend
many people's sense of economic justice.
Indeed, the salary premium paid by the
financial service sector clearly motivated
the application of an STT in Sweden in the
1980s (see Umlauf, 1993 ).

STT proponents have not articulated a
detailed account of how the tax will
amend the alleged financial market ineffi-
ciencies they cite to garner support for the
proposal. The pro-tax analysis rests on the
premise that an STT will make short-hori-
zon trading strategies unprofitable and
thereby reduce trading volume and the
amount of resources dedicated to these so-
cially unproductive pursuits. Regardless
of the effects an STT may have on short-
term rent seeking activities, the tax will
have additional effects with potentially
important economic consequences. An
STT will change the relative returns on fi-
nancial instruments. Such changes could
favor derivative investments over cash
market transactions or, alternatively, alter
relative returns so that derivative transac-
tions become altogether unprofitable. The
STT may distort information flows, com-
promise the insurance efficiency that ex-
isting financial instruments provide, or
alter the market prices of financial assets
so that they less accurately reflect their un-
derlying fundamental economic values.
Such a tax may have effects on price vol-
atility and almost certainly will alter
investors' required rates of return on fi-
nancial instruments.

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