Should we throw sand in the gears of financial markets?

The volatility of financial markets in recent years has led to increased concern. As trading of financial assets on organized exchanges and over-the-counter markets has grown, events such as the 1987 stock market crash and the 1992 Exchange Rate Mechanism crisis in Europe have raised fundamental questions about the role these markets play in the economy. In particular, there is concern that much of the increased trading of financial assets is of a short-term, speculative nature that adds little value to the intermediation process and in the extreme case may distort the efficient functioning of financial markets.> This view has led some economists to advocate a securities transaction tax. Such a tax, it is argued, when applied to a broad range of financial transactions, would raise the cost of short-term speculative trading, reduce financial market volatility, and improve the efficiency of financial markets. This type of tax might also raise substantial revenue that could help reduce the federal budget deficit. The revenue potential has not gone unnoticed in Washington, where recent budget proposals by both the Bush and Clinton administrations have included an STT.> Hakkio explores the pros and cons of a securities transaction tax. He concludes that the proponents have overstated the likely benefits of a securities transaction tax and underestimated the potential costs.