Financial Transactions Tax

The 2008 Year In Ideas issue of the New York Times Sunday Magazine might have been the best issue I've ever read. There were several items here that caught my attention, and a I hope to write about all of them at some point, but I'll start with one that seems particularly timely.

The concept is simple:

impose a small tax on the sale or transfer of stocks, bonds, derivatives and other securities, thereby encouraging people to “buy and hold” rather than to engage in the frenetic transactions typical of a speculative bubble.

This appeals to me for many reasons.

1. It essentially penalizes people who make a living exploiting incremental ups and downs in the market, or arbitrage across different markets. These transactions add no value and are nothing more than a numbers game that has very little to do with the inherent value of an entity. Markets are powerful and efficient, but I'm not sure that split second timing of fractions of percentage points is legitimate. At the very least, it would be useful to make these people pay a steeper price.

2. It raises desperately needed tax revenue from a place that was in many ways the root cause of our current financial calamity.

So, political arguments aside, why wouldn't this be a great idea? I posed this question to some of my finance friends and they came back with:

I think it would deter a lot of bond investors where returns are minimal to begin with. Also if you have a couple million dollar retirement portfolio and you are making a few big trades a year or a redistribution, that will come out to a lot of money in taxes you are paying.

Both valid points. I understand the bond argument, and it's certainly a good idea to keep that market liquid, so perhaps they could be omitted. I think it's most important that this tax be applied to stocks and derivatives in order to dissuade speculative day traders and those folks who enjoy turning weird things into tradable commodities a la CDO's, CDS's, etc.. They should have to pay a fee at each stage of derivation (?) if that makes sense. The benefits here are numerous - generate revenue, slow down this phenomenon to allow for more appropriate oversight, and decrease the incentive to perform such transactions in the first place.

Again, I'm not sure how any of this would be implemented or if it even makes much sense. It just seems like a good idea to me.

As for the retirement portfolio argument, there are already plenty of tax incentives built into 401k's and whatnot, so it wouldn't be terribly difficult to add an exception there as well.

Comments are welcome.