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Optimal Financial Transaction Taxes

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  • Eduardo Davila

    (Harvard University)

Abstract

This paper characterizes the optimal linear financial transaction tax in an equilibrium model of competitive financial markets. When belief disagreement induces excess trading on assets in fixed supply, two main results arise. First, the optimal tax is positive: although a (small) transaction tax discourages all trades equally, the reduction in fundamental trading creates a second-order welfare loss, while the reduction in non-fundamental trading creates a first-order gain. Second, the cross-sectional covariance between investors’ beliefs and investors’ equilibrium portfolio tax sensitivities becomes the relevant sufficient statistic for the optimal tax, which does not depend on the actual payoff distribution. I find additional results. First, in dynamic environments, controlling for the level of static disagreement, the optimal tax is lower when investors alternate between being buyers and sellers over time. Second, when financial markets determine production in a Walrasian sense, as in a q-theory environment, a marginal tax increase creates an additional first-order distortion (positive or negative). Third, when financial markets determine production by diffusing information, a marginal tax increase creates an additional first-order loss, due to a learning externality.

Suggested Citation

  • Eduardo Davila, 2014. "Optimal Financial Transaction Taxes," 2014 Meeting Papers 114, Society for Economic Dynamics.
  • Handle: RePEc:red:sed014:114
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    File URL: https://economicdynamics.org/meetpapers/2014/paper_114.pdf
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    References listed on IDEAS

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    11. Ross, S.A., 1989. "Commentary: Using Tax Policy To Curb Speculative Short-Term Trading," Papers t3, Columbia - Center for Futures Markets.
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    13. David M. Kreps, 2012. "Microeconomic Foundations I: Choice and Competitive Markets," Economics Books, Princeton University Press, edition 1, number 9890, October.
    14. Karl F Habermeier & Andrei A Kirilenko, 2001. "Securities Transaction Taxes and Financial Markets," IMF Working Papers 01/51, International Monetary Fund.
    15. Kopczuk, Wojciech, 2003. "A note on optimal taxation in the presence of externalities," Economics Letters, Elsevier, vol. 80(1), pages 81-86, July.
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    Cited by:

    1. Emmanuel Farhi & Xavier Gabaix, 2015. "Optimal Taxation with Behavioral Agents," Working Paper 305366, Harvard University OpenScholar.
    2. Michael Bailey & Ruiqing Cao & Theresa Kuchler & Johannes Stroebel, 2016. "Social Networks and Housing Markets," NBER Working Papers 22258, National Bureau of Economic Research, Inc.
    3. repec:spr:finsto:v:22:y:2018:i:2:d:10.1007_s00780-018-0354-x is not listed on IDEAS

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