## 1. Securities Transaction Taxes in G20 and Selected Other Countries, 2010

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### Context and mandate
- G-20 Pittsburgh (September 2009) tasked the IMF to explore options for financial sector contributions to costs of government interventions.
- IMF (2010) dual approach:
  - Recommend levies on financial institutions to pay for resolution of troubled institutions.
  - Examine revenue-raising from sector activities, including FTTs, while ultimately favoring a financial activities tax (FAT) on profits and wages.
- This paper focuses on securities and currency transaction taxes (STTs and CTTs).

### Purposes attributed to FTTs / STTs
- Purposes advanced by supporters:
  - Raising revenue from the financial sector to help pay crisis costs or for global development.
  - Reducing financial market risk and helping to prevent asset price bubbles.
- Ease of collection on exchange-traded instruments cited as an additional rationale.

### Observed practice and recent attention
- Several G-20 governments (including France and Germany) considered or supported FTTs; H.M. Treasury (2009) examined implications.
- European Parliament (March 2010) commissioned a study and tasked the European Commission with developing a European FTT.
- Civil society groups, including the Leading Group on Innovative Financing for Development, support some form of global FTT (securities or foreign currency).

### Empirical patterns and revenue characteristics
- Common design: ad valorem tax on share trades of 10–50 basis points in many G-20 countries.
- Typical yields: on average, these taxes tend to raise less than 0.5 percent of GDP, with yields fluctuating over the market cycle.
- Long-run trend: STTs have generally trended downwards over the past two decades as governments lower capital costs and boost financial market competitiveness.

### Gaps in literature and unresolved questions
- Documented: predictable effects of FTTs on asset valuation and trading volume, with implications for liquidity and price discovery.
- Largely unexplored areas:
  - Effects of transaction costs on market dynamics, including short- and long-term price volatility.
  - Incidence of FTTs across economic agents.
  - Distortions of STTs relative to other types of taxes.
- Policy tension: FTTs levy a low rate on a broad base but conflict with tax policy precept that gross transaction taxes cascade and distort production.

### Typology of financial transactions taxes (definitions)
- Securities transactions tax (STT): tax on trades in securities (equity, debt and derivatives); commonly ad valorem on market value; may cover primary issuance or only secondary trades.
- Currency transaction tax (CTT) / Tobin tax: tax on foreign exchange transactions and possibly derivatives; sometimes used as pecuniary foreign exchange control.
- Capital levy or registration tax: tax on increases in business capital (capital contributions, loans, issuance of stocks/bonds); can include registration taxes on bank loans/mortgages.
- Bank transaction tax (BTT): tax on deposits and/or withdrawals; usually ad valorem; effectively taxes purchases and payments intermediated by banks.

### Box 1 — Bank Transaction Taxes: key findings
- Large base: BTTs often tap a base much larger than GDP, so low rates can yield substantial revenue.
- Administrative ease: a small number of large financial institutions can withhold and remit the tax.
- Observed rates and yields: Latin American BTTs in use in 2009 had rates ranging from 15 to 150 basis points and yielded between 0.3 and 1.9 percent of GDP (Coelho, 2009).
- Dynamics:
  - Revenues tend to erode over time via cash payments, multiple check endorsements, offshore accounts.
  - Kirilenko and Summers (2004) and Baca-Campodonico, and others (2006) find BTT revenues decline over time for a given rate.
  - Governments often raise rates to shore up revenue, causing sharper base contraction; BTTs are frequently repealed within a few years.
- Economic costs:
  - Banks pass BTTs into higher interest spreads, discouraging investment and raising government borrowing costs.
  - BTTs create lock-in effects analogous to STTs; countries (e.g., Brazil) created special investment accounts exempt from BTT to mitigate this.
  - Evidence: Kirilenko and Summers (2004) find the bank transaction base in three Latin American countries contracted 28–47 percent after BTT imposition, corresponding to deadweight losses of 30–45 percent of BTT revenue.
- Incidence complexities:
  - BTTs can act as a consumption tax with varying effective rates across products; incidence may fall more heavily on small businesses than large producers.
- Implication for STTs: share features with STTs (large base, ease of collection, avoidance risk, lock-in, cascade effects); short-term revenue gains must be weighed against long-term instability and macroeconomic costs.

*Source: 1. Securities Transaction Taxes in G20 and Selected Other Countries, 2010.*

---

### IV. The Economics of Securities Transaction Taxes — A. Evolution of the Debate
- Historical advocates:
  - Keynes advocated a “substantial Government transfer tax” to curb speculation.
  - Tobin (1978) proposed a one percent tax on all foreign exchange transactions.
- Contemporary proposals favor very low rates to avoid liquidity harm or migration offshore: rates as low as one-half basis point (Pollin and others, 2002; Schulmeister and others, 2008; Schmidt, 2007; Kapoor and others, 2007; Spratt, 2006; European Parliament, 2010).
- Shift in literature: from market regulation to revenue-raising, with occasional hopes for therapeutic effects.
- Opposing claims:
  - Proponents (Stiglitz; Summers and Summers) argue STTs curb short-term speculation and volatility.
  - Opponents (Habermeier and Kirilenko; Schwert and Seguin) argue STTs lower asset prices, increase cost of capital, reduce liquidity, interfere with price discovery, and prompt evasion.

### IV. The Economics of Securities Transaction Taxes — B. Behavioral Effects
- Transaction taxes increase transaction costs, akin to wider bid-ask spreads or higher commissions.
- Effects on savings and consumption:
  - Like capital income taxes, transaction taxes lower returns to savings and can either encourage current consumption (via substitution) or reduce it (via income effect); net impact depends on substitution vs. income effects (Li, 2009).
- No-trade zone and holding periods:
  - Transaction costs create a “no trade zone” around optimal portfolios (Constantinides, 1986).
  - Short-term trading is suppressed more than long-term trading.
- Interaction with capital gains tax (CGT):
  - CGT lock-in increases with holding period; STT lock-in tends to diminish with holding period and deters trading irrespective of gains/losses.
  - Higher transaction costs amplify CGT lock-in effects (Dammon and Spatt, 1996).
- Risk-taking:
  - STTs discourage risk-taking by imposing costs on both good and bad realizations, reducing demand for risky assets among risk-averse investors.

### IV. The Economics of Securities Transaction Taxes — C. Asset Valuation and Cost of Capital
- Consensus: higher transaction costs including STTs are associated with lower asset prices (Kupiecs, 1996; McCrae, 2002).
- Liquidity premium evidence: illiquid privately held companies valued at 20–25 percent less than comparable publicly traded firms (Block, 2007).
- Model summary (ad valorem STT rate T, holding period N, discount rate r, dividend growth g, R = r - g):
  - Proportional reduction in value, ∆, increases in T (decreasing rate) and decreases in N and R.
  - Approximate effect on cost of capital: increase in discount rate of T/N.
- Illustrative magnitudes:
  - Very short holding periods (one day): a one basis point STT can reduce securities value by almost half.
  - Very long holding periods (10 years): a 50 basis point STT reduces value by 1.4 percent.
  - Average holding period for S&P 500 stocks in 2009: 0.4 years; in 1990: 1.8 years (Datastream).
  - For stocks with a 0.4 year holding period:
    - A one basis point STT would reduce market value by 0.8 percent and increase cost of capital by about 3 basis points.
    - A 10 basis point STT would reduce market value by 7.6 percent and increase cost of capital by about 25 basis points.
  - Corporate bonds trade less frequently; a low-rate (5 basis points or less) STT likely has a modest overall impact on corporate cost of capital.
- Table 4 — Percentage reduction in security value due to an STT (R = 0.03) — selected exact entries:
  - Average Holding Period (Years) = 1:
    - 0.10 -> 3.2%
    - 0.25 -> 1.3%
    - 0.5  -> 0.7%
    - 1    -> 0.3%
    - 10   -> 0.0%
  - Average Holding Period (Years) = 5:
    - 0.10 -> 14.3%
    - 0.25 -> 6.2%
    - 0.5  -> 3.2%
    - 1    -> 1.6%
    - 10   -> 0.1%
  - Average Holding Period (Years) = 10:
    - 0.10 -> 25.0%
    - 0.25 -> 11.7%
    - 0.5  -> 6.2%
    - 1    -> 3.2%
    - 10   -> 0.3%
  - Average Holding Period (Years) = 25:
    - 0.10 -> 45.4%
    - 0.25 -> 24.9%
    - 0.5  -> 14.2%
    - 1    -> 7.6%
    - 10   -> 0.7%
  - Average Holding Period (Years) = 50:
    - 0.10 -> 62.5%
    - 0.25 -> 39.9%
    - 0.5  -> 24.9%
    - 1    -> 14.1%
    - 10   -> 1.4%
- Table 4 — Increase in Cost of Capital — Percentage Points (R = 0.03) — selected exact entries:
  - Average Holding Period (Years) = 1:
    - 0.10 -> 0.10
    - 0.25 -> 0.04
    - 0.5  -> 0.02
    - 1    -> 0.01
  - Average Holding Period (Years) = 5:
    - 0.10 -> 0.50
    - 0.25 -> 0.20
    - 0.5  -> 0.10
    - 1    -> 0.05
  - Average Holding Period (Years) = 10:
    - 0.10 -> 1.00
    - 0.25 -> 0.40
    - 0.5  -> 0.20
    - 1    -> 0.10
  - Average Holding Period (Years) = 25:
    - 0.10 -> 2.50
    - 0.25 -> 1.00
    - 0.5  -> 0.50
    - 1    -> 0.25
  - Average Holding Period (Years) = 50:
    - 0.10 -> 5.00
    - 0.25 -> 2.00
    - 0.5  -> 1.00
    - 1    -> 0.50
- Empirical example:
  - Umlauf (1993): 1983 imposition of a one percent tax on equity trades in Sweden resulted in a market decline of about 5.3 percent on the Stockholm stock exchange in the 30 days leading up to the tax.

---

### Impact on cost of capital and share prices (cross-country evidence)
- Hu (1998): across 14 STT changes in Hong Kong, Japan, Korea, and Taiwan (1975–1994), a 23 percent rise in transaction costs causes an immediate one percent decline in daily market returns on average.
- Schwert and Seguin (1993): a 0.5 percent STT in the U.S. would increase the cost of capital by between 10 and 180 basis points.
- Oxera (2007): abolition of the 0.5 percent U.K. stamp duty would increase share prices by 7.2 percent and reduce cost of capital by between 66 and 80 basis points.
- Bond and others (2004): the 50 percent cut in Britain’s Stamp Duty (1986) increased share prices, especially for high-turnover shares; eliminating remaining 50 basis points predicted to increase share prices between 2.5 and 6.3 percent, depending negatively on dividend yield and positively on market turnover.
- Auten and Matheson (2010): U.S. SEC low-rate fee (less than 0.5 basis points) reduces trading only in the largest, most liquid equities.

### Turnover, liquidity, and price discovery
- STTs reduce trading volume by making some trades unprofitable; reduced volume generally reduces liquidity (price impact from a given trade).
- Empirical elasticities of trading volume w.r.t. transaction costs generally range between -0.5 and -1.7. Selected exact findings:
  - Jackson and O’Donnell (1985): short-run trading volume elasticity -0.5 and long-run -1.7 for the U.K.
  - Umlauf (1992): a 100 percent increase in Swedish STT in 1986 resulted in a 60 percent fall in trading for 11 most actively traded Swedish stocks.
  - Baltagi and others (2006): China STT increase (0.3 to 0.5 percent) reduced trading volume by one-third, implying elasticity -0.5 w.r.t. the tax and about -1 w.r.t. TTC.
  - Wang et al. (1997): U.S. S&P 500 Index Futures (CME) elasticity -2 (BAS).
  - Hu (1998): no impact finding — elasticity 0 (STT) in multinational stock markets entry.
- Fixed-income markets: Sweden’s 0.2 to 3 basis point STT on bonds produced sharp drops; long-term bond trading fell 85 percent upon announcement.
- Foreign exchange: Schmidt (2007) estimates elasticity -0.4 for a multilateral tax on four largest trading currencies.
- Futures markets: long-run elasticities typically exceed short-run elasticities; Chou and Wang (2006) found 50 percent reduction in Taiwan’s STT on futures induced commensurate trading volume increase.
- Trade reallocation:
  - Umlauf (1993) and Froot and Campbell (1994): Swedish STT led to migration of trading from Stockholm to London.
  - Chou and Wang (2006): STT reduction in Taiwan induced migration of trade from Singapore to Taiwan.

### Price discovery and autocorrelation
- Studies on autocorrelation changes post-STT:
  - Liu (2007): reduction of Japanese STT in 1989 reduced first-order autocorrelation of price changes.
  - Baltagi and others (2006): increase in China’s STT rate increases autocorrelation of returns.

### Market dynamics, transaction costs, and efficiency
- Policy rationale for a broad-based STT: curb short-term and derivatives trading seen as speculative noise-trading that promotes excess volatility and bubbles (Schulmeister and others, 2008).
- Secular trends:
  - Commission deregulation (1975) and decimalization (2000) lowered U.S. equity transaction costs (NYSE bid/ask spreads: about 0.1 percent vs. 1.3 percent in mid-1980s).
  - FX bid-ask spreads for major currencies now as little as 1–4 basis points.
  - Value of world financial transactions: 25 times world GDP in 1995 and 70 times by 2007 (European Parliament, 2010).
- Algorithmic and high-frequency trading (HFT):
  - Algorithm trading accounted for at least 60 percent of U.S. equity trading volume in 2009 (up from about 30 percent in 2006), and 30–40 percent of European and Japanese equity trading.
  - Algorithm trading accounts for 10–20 percent of FX volume, 20 percent of U.S. options volume, and 40 percent of U.S. futures volume (Reuters, 2009).
  - Concerns include market dislocation from technical malfunction, herding, and increased leverage via derivatives.

### Volatility: short-term vs long-term price swings
- Theoretical ambiguity: STTs may either raise or lower volatility depending on whether liquidity providers or noise traders are more affected.
- Empirical evidence mixed:
  - Roll (1989): no consistent relationship across 23 countries.
  - Baltagi and others (2006): no impact of China’s STT increase on volatility.
  - Jones and Seguin (1997): U.S. commission deregulation (lowered transaction costs) led to decreased volatility.
  - Green and others (2000): U.K. stamp duty increases generally lead to higher short-term volatility.
- Bubbles and crashes often attributed to leverage cycles; high transaction costs in real estate coexist with frequent bubbles, suggesting low-rate STT unlikely to prevent bubbles.
- Taxing derivatives or notional values could raise effective rates with leverage to discourage leverage.

---

### Impact on short-term volatility and trading activity
- Empirical studies often focus on short-term volatility; results show either no effect or positive effect of transaction costs on volatility.
- Trading itself generates short-term volatility (French and Roll, 1986; Barclay, and others, 1990), so reducing trading could reduce trading-generated volatility.
- STTs do not reliably distinguish stabilizing vs destabilizing trades; this inability is a key reason for skepticism among analysts (Bloomfield, and others, 2009; Chaboud and others, 2009).

### Efficiency, “waste,” and liquidity valuation
- Debate on social value of short-term trading: critics call it waste; proponents emphasize liquidity and price discovery benefits.
- Liquidity valuation: investors accept lower returns for more liquid securities (Amihud and Mendelson, 2005).
- Emerging markets should be cautious introducing STTs due to potential development costs.

### Incidence and distributional effects
- Short-run burden:
  - Owners of traded securities at STT introduction bear a large share via immediate price declines equal to present value of expected future STT liabilities.
  - Likely progressive effect: high-income individuals hold disproportionate share of financial assets.
  - U.S. 2007 holdings (Table 6 examples):
    - Top decile by income owned 81 percent of bonds, 63 percent of stocks, 57 percent of investment funds, and 56 percent of retirement account assets.
    - At least 52 percent of these four asset groups are held by taxpayers 55 and older.
    - At least 88 percent are held by taxpayers 45 and older.
- Long-run incidence depends on capital mobility:
  - Small open economy: capital flows out until after-tax return equals world level; burden falls on workers.
  - Less elastic capital supply: burden shared between capital owners and workers.
- Sectoral impacts:
  - Financial firms’ dealing, trading, underwriting profits contract; sector may employ fewer resources and compensation for highly skilled workers may decline.
  - STTs are more distortive than net-income or value-added taxes because they tax gross transaction values and cascade through production.
  - STTs disproportionately burden sectors with heavy issuance/trading: financial sector, pension funds, public corporations, international commerce firms, and public entities (if government bonds taxed).
- Cascading:
  - Transaction taxes are not creditable; even low-rate STTs can impose high effective burdens through cascading.

### Alternatives and policy options
- Regulatory/tax alternatives to discourage leverage or raise revenue:
  - Increase margin/collateral requirements.
  - Tax on balance sheet debt (net of insured deposits and equity), e.g., financial sector contribution (FSC).
  - Corporate tax reform to reduce debt bias: reduce/eliminate interest deductibility or introduce an allowance for corporate equity (ACE).
  - Apply transactions tax on full notional value of leveraged transactions to discourage leverage.
- Revenue-raising alternatives:
  - Broaden VAT to include fee-based financial services; apply VAT to bank interest margins (systems exist but not widely implemented).
  - Financial activities tax (FAT) on net value added or compensation and profits above a threshold; less distortive than an FTT.
- STT as second-best:
  - European Parliament (2010) views low-level STT as provisional second-best where regulation is weak; STT does not directly address systemic risk or complexity.

### STT design: major considerations and recommendations
- Broad principles:
  - Broader base across instrument types and substitutes reduces revenue erosion and allows lower rates.
  - Taxing both debt and equity reduces financing distortions.
  - Cannot impose identical burdens on economically equivalent contracts due to transactional intensity differences.
- Tax base and instruments:
  - Recommended coverage: transactions in all traded securities—equity, debt, foreign exchange—and their derivatives.
  - Taxing public sector debt controversial: raises government borrowing costs and may generate net fiscal loss; exempting public bonds may draw liquidity away from private bonds.
  - Derivatives:
    - Futures/forwards: tax on spot or delivery price since initial market value may be zero.
    - Swaps: could be taxed on notional value; swaps viewed as 100 percent leveraged and in theory taxed at twice underlying trade rate; anti-abuse rules needed.
    - Options: tax bases include premium, strike price if executed, or spot value at transaction time; taxing full notional penalizes leverage.
  - Pass-through entities and pooled funds: trades in investment trusts should be taxable to prevent avoidance; design must consider double taxation vs avoidance.
  - Exchange-traded vs OTC:
    - Most STTs apply to exchange-traded securities cleared through central clearing houses (easier administration).
    - Exempting OTC incentivizes migration to OTC; taxing OTC is administratively harder and may require reporting by financial institutions.
  - Territoriality and entity status:
    - Choices on residency, location of trade, nationality of transactors, and issuer affect evasion and administration.
    - Intermediary relief reduces cascading but may invite avoidance; taxing financial institutions’ own-account trades preferred when feasible.
- Rate structure and calibration:
  - Ad valorem vs flat fees:
    - Most STTs are ad valorem; some flat-fee examples exist (e.g., New York State up to five cents per share with a $350 cap).
    - Fixed rates tax small trades relatively more, encouraging order aggregation.
  - Relationship to pretax transaction costs:
    - Equal STT rates across markets with different pretax costs raise total costs proportionately more in low-cost markets.
    - Example: India taxes stock option premiums and futures at lower rates than stocks (1.7 basis points vs 12.5 basis points).
  - Maturity effects:
    - Uniform STT on issuance can distort maturity choices; responses include lower rates on short-term paper or multiplying base rates by years to maturity.
- Administrative and avoidance considerations:
  - Use share registration or contract recognition as administrative handles.
  - Centralized clearance lowers collection costs: U.K. CREST collection cost 0.09 pence per pound vs all-tax average cost 1.11 pence.
  - Historical lesson: Swedish equity tax (1984–1991) was avoided via non-Swedish brokers, prompting migration.
  - U.K. stamp duty taxed registration of U.K. shares, reducing offshore migration incentives.

### Empirical market changes and implications
- U.S. bond market turnover fell from 8.5 times per year in 2005 to 5.9 times per year in 2009 as trading migrated to swaps.
- Many derivatives, especially OTC, trade infrequently; STTs should cover initial issuance as well as subsequent trades.

### Multilateralism and revenue allocation
- Unilateral STTs are feasible; major centers (U.K., Switzerland, Hong Kong, Singapore, South Africa) levy STT forms without necessarily driving out activity.
- Coordinated STT adoption reduces base elasticity and improves revenue stability; governance and revenue allocation pose challenges.
- Revenue apportionment: host financial centers (e.g., U.K.) would raise more revenue; allocation could be based on member GDP or total use of financial services.

---

### Box 2 — The United Kingdom Stamp Duty: overview and policy lessons
- Revenue performance:
  - Average revenue: £3.3 billion per year, or almost 0.3 percent of GDP, since 2000 (Stamp Duty on shares only).
- Statutory rate often cited: 0.5 percent (50 basis points); because base is gross transaction value, 50 basis points is effectively high.
- Institutional non-tax transaction costs average about 25 basis points; 50 basis points triples total transaction costs for such trades.
- Exemptions and avoidance:
  - Equity derivatives that do not result in share purchases exempted; exemption creates incentive to seek equity exposure via derivatives, increasing leverage.
  - Charities exempt; pension funds and hedge funds not exempt. Due to intermediary relief and exemptions, about 20 percent of LSE share trading is subject to stamp duty (Oxera, 2006).
- Geographic neutrality:
  - Duty applies to trades in U.K.-registered shares regardless of trade location; does not apply to foreign corporations listed in London unless a U.K. share registry exists.
  - Historical avoidance via depository receipts and street-name accounts prompted a “season ticket” charge of 1.5 percent on equity committed to these schemes (from 1986).
- Empirical and quantitative findings (selected exact estimates):
  - Low-rate (0.5–1 basis point) multilateral CTT on four major currencies could raise about $20–40 billion annually, or roughly 0.05 percent of world GDP.
  - A one basis point STT on global stocks, bonds and derivatives is estimated to raise approximately 0.4 percent of world GDP.
  - Average transaction cost for ordinary corporate equity trades in major centers: about 25 basis points.
  - Example: If a 2 basis point STT reduced turnover on the S&P 500 to the average level of 2005 (0.8 years), it would initially lower stock values by roughly 1 percent and raise the cost of capital by 3 basis points.
  - SIFMA: average holding period for corporate bonds in 2009 was 1.6 years.
- Economic effects and efficiency considerations (summary):
  - STTs reduce security values and raise cost of capital, particularly for frequently traded securities.
  - STTs reduce trading volume, reduce liquidity, and slow price discovery.
  - No convincing evidence that STTs lower short-term price volatility; high transaction costs are likely to increase volatility.
  - Short-run incidence tends to be progressive; medium/long-run incidence depends on capital supply elasticity.
- Policy recommendations and best-practice lessons:
  - Consider more efficient alternatives before adopting an STT: reduce debt bias in corporate taxation; tax balance-sheet debt (FSC); broaden VAT to fee-based financial services; introduce an FAT.
  - If adopting an STT for significant revenue:
    - Apply a low-rate tax to all securities and derivatives transactions, including OTC, to minimize distortions.
    - Broad base is harder to avoid than narrow base, but all STT bases vulnerable to erosion via innovation and integration.
    - Multilateral STTs have less elastic bases, allowing lower rates for a revenue target.
    - Difficult to justify a tax solely on foreign exchange transactions: it would raise much less revenue on a more elastic base and OTC nature complicates administration.
  - Note: Imposition of even a low-rate STT on HFT and narrow-margin markets (currencies and futures) would reduce trading volume dramatically; as non-tax transaction costs decline, relative impact of an STT on total transaction costs increases over time.

*Source: IMF working paper content (content unit _wp1154).*

### 1. Securities Transaction Taxes in G20 and Selected Other Countries, 2010 ...........................8

### 1. Securities Transaction Taxes in G20 and Selected Other Countries, 2010

### Context and mandate
- At their Pittsburgh meeting in September 2009, the G-20 leaders tasked the IMF to explore “the range of options countries have adopted or are considering as to how the financial sector could make a fair and substantial contribution toward paying for any burdens associated with government interventions to repair the banking system.”
- IMF (2010) adopted a dual approach:
  - Recommend levies on financial institutions to pay for resolution of troubled institutions in future failures and crises.
  - Examine the possibility of raising revenue from the sector’s activities more generally, including consideration of financial transactions taxes (FTTs), while ultimately favoring a “financial activities tax” (FAT) levied on the sum of financial institutions profits and wages.
- The report did not rule out use of FTTs for other purposes and this paper focuses on securities and currency transaction taxes (STTs and CTTs).

### Purposes attributed to FTTs / STTs
- Supporters seek one or both of:
  - Raising revenue from the financial sector to help pay for costs of the recent financial crisis or for global development.
  - Reducing financial market risk and helping to prevent asset price bubbles.
- Ease of collection on exchange-traded instruments is also cited as a reason to adopt such taxes.

### Observed practice and recent attention
- Several G-20 governments, including France and Germany, have shown support for FTTs; H.M. Treasury (2009) considered implications of an FTT for financial markets.
- The European Parliament (March 2010) released a study and charged the European Commission with developing plans for a European FTT.
- Numerous civil society organizations, including the Leading Group on Innovative Financing for Development, support adoption of some form of a global FTT (on all securities transactions or on foreign currency transactions).

### Empirical patterns and revenue characteristics
- Many G-20 countries currently impose some sort of financial transactions tax, most commonly an ad valorem tax on share trades of 10–50 basis points.
- On average, these taxes tend to raise less than 0.5 percent of GDP, although their yields fluctuate over the market cycle.
- The general trend in STTs over the past two decades has been downwards as governments seek to lower capital costs and boost competitiveness of domestic financial markets.

### Gaps in the literature and unresolved questions
- Predictable effects of FTTs on asset valuation and trading volume are documented, with implications for liquidity and price discovery.
- Several areas remain largely unexplored:
  - Effects of transaction costs on market dynamics, including short- and long-term price volatility.
  - Incidence of FTTs across economic agents.
  - Distortions of STTs relative to other types of taxes.
- Although FTTs conform to levying a low rate on a broad base, they conflict with the tax policy precept that gross transaction taxes cascade and distort production and should be avoided when more efficient instruments are available.

### Structure of the paper (as presented)
- Section II: Categorizes different types of financial transactions taxes.
- Section III: Reviews current use of financial transaction taxes and revenue yields in G-20 and selected non-G-20 financial centers.
- Section IV: Reviews economics of securities transaction taxes, including incidence and behavioral effects.
- Section V: Discusses design considerations for a hypothetical STT to minimize distortions and evasion.
- Section VI: Concludes.

### Typology of financial transactions taxes (definitions and features)
- Securities transactions tax (STT):
  - Tax on trades in all or certain types of securities (equity, debt and their derivatives).
  - May include original issuance or be restricted to secondary market trades.
  - More commonly an ad valorem tax based on market value; sometimes a flat fee per trade.
- Currency transaction tax (CTT) or Tobin tax:
  - Tax imposed specifically on foreign exchange transactions and possibly their derivatives: currency futures, options and swaps.
  - Often used as a pecuniary foreign exchange control in lieu of administrative and regulatory measures.
- Capital levy or registration tax:
  - Imposed on increases in business capital in the form of capital contributions, loans and/or issuance of stocks and bonds.
  - May encompass all forms of business capital or be limited to a particular type (e.g., debt or equity) or form of business (corporations or partnerships).
  - A registration tax may also be charged to individuals on bank loans and/or mortgages.
- Bank transaction tax (BTT):
  - Tax on deposits and/or withdrawals from bank accounts.
  - Most commonly seen in Latin American and Asia; usually ad valorem as a percentage of the deposit or withdrawal.
  - Effectively taxes purchases of goods and services, investment products and factor payments paid for with funds intermediated by banks.
  - See Box 1 for further discussion (Box not reproduced here).

*Source: 1. Securities Transaction Taxes in G20 and Selected Other Countries, 2010.*

### Box 1. Bank Transaction Taxes

### Box 1. Bank Transaction Taxes

### Key findings on design, revenue potential, and dynamics
- Bank transaction taxes (BTTs) offer a large taxable base—usually much larger than GDP—so a substantial amount of revenue can be raised with a fairly low rate.
- BTTs are easily administered because a small number of large financial institutions withhold and remit the tax on customers’ transactions.
- BTTs in use in Latin America in 2009 had rates ranging from 15 to 150 basis points and yielded between 0.3 and 1.9 percent of GDP (Coelho, 2009).
- BTT use swelled in Latin America and Asia over the past decade due largely to financial crises, peaking in 2005, when eight Latin countries and five Asian countries imposed them; of these 13 taxes, only eight remained in force by 2009 (Coelho, 2009).

### Revenue erosion, behavioral responses, and policy instability
- Empirical evidence indicates BTT revenues tend to erode over time as taxpayers avoid them via cash payments, multiple check endorsements, and offshore bank accounts.
- Kirilenko and Summers (2004) and Baca-Campodonico, and others (2006) find that, for a given tax rate, BTT revenues decline over time.
- Governments frequently raise rates to shore up revenues, but higher rates often cause a sharper contraction of the tax base; as a result, BTT rates tend to be unstable and the taxes are frequently repealed within a few years of enactment.

### Economic costs, market effects, and distributional incidence
- Banks collecting BTTs typically charge higher interest rate spreads to recoup profitability, which:
  - Discourages investment.
  - Raises the cost of government borrowing, lowering the net fiscal benefit from a BTT.
- Charging a BTT on investment-related transfers creates a lock-in effect identical to that of an STT; some countries (e.g., Brazil) have created special investment accounts within which transfers are BTT-exempt to mitigate this effect.
- By reducing financial intermediation, BTTs undermine savings, investment, and growth, particularly in emerging market economies.
- Kirilenko and Summers (2004) find the bank transaction base in three Latin American countries contracted 28–47 percent in response to BTT imposition, corresponding to deadweight losses of 30–45 percent of BTT revenue.
- As a gross transactions tax, BTTs can cascade through the production chain, producing multiple layers of tax on goods and services produced using bank-mediated transfers; this cascading tends to encourage vertical integration of production processes irrespective of efficiency.
- The incidence of a transaction tax (BTT or STT) can be complex and unpredictable:
  - Though sometimes portrayed as progressive, a BTT may fall primarily on customers rather than on financial institutions or their owners.
  - Arbalaez, and others (2005) describe the BTT as a consumption tax with a rate that varies arbitrarily across products; its incidence therefore depends on the transaction intensity of consumer products and on consumption patterns, and will fall more heavily on small businesses than on large, integrated producers.

### Implications for STTs and policy takeaways
- Country experiences with BTTs are instructive for securities transaction taxes (STTs): both tax types share features such as large bases, ease of collection via financial intermediaries, potential revenue erosion due to avoidance, lock-in effects on investment, and cascading/incidence complexities.
- Policymakers should weigh short-term revenue gains from BTTs against:
  - Long-term revenue instability and avoidance behaviors.
  - Macroeconomic costs from higher borrowing and reduced intermediation.
  - Distributional consequences that may disproportionately affect small businesses and certain consumers.
- Design choices (e.g., exemptions for investment accounts) can mitigate some lock-in effects but do not eliminate base erosion or cascading consequences.

*Source: Box 1. Bank Transaction Taxes, IMF working paper content.*

### 2.5 percent under a 0.5 basis point tax, and 5 percent under a one basis point tax. Given

### _wp1154 - 2.5 percent under a 0.5 basis point tax, and 5 percent under a one basis point tax. Given

### IV. THE ECONOMICS OF SECURITIES TRANSACTION TAXES — A. Evolution of the Debate
- Early proponents:
  - Keynes: argued for a “substantial Government transfer tax” to curb speculation while noting the tradeoff with financing of real enterprise.
  - Tobin (1978): proposed a one percent tax on all foreign exchange transactions to limit cross-border capital flows.
- Modern advocates and rates:
  - Contemporary FTT advocates propose rates as low as one-half basis point to avoid impairing liquidity or driving activity offshore (Pollin and others, 2002; Schulmeister and others, 2008; Schmidt, 2007; Kapoor and others, 2007; Spratt, 2006; European Parliament, 2010).
  - Focus of FTT literature largely shifted from financial market regulation to revenue raising, with occasional hope of therapeutic effects on market excesses.
- Key opposing claims:
  - Proponents (e.g., Stiglitz, 1989; Summers and Summers, 1989) claim STTs would curtail short-term speculation, reduce wasted resources, market volatility, and asset mispricing.
  - Opponents (e.g., Habermeier and Kirilenko, 2003; Schwert and Seguin, 1993) argue STTs lower asset prices, increase cost of capital, reduce returns to savings, reduce liquidity, increase price volatility, interfere with price discovery, and prompt evasion and market distortion.

### IV. THE ECONOMICS OF SECURITIES TRANSACTION TAXES — B. Behavioral Effects
- Transaction taxes raise transaction costs akin to widening bid-ask spreads or higher commissions.
- Effects on savings and consumption:
  - Like capital income taxes, transaction taxes lower the return to savings and can either encourage current consumption (by raising relative cost of future consumption) or decrease current consumption (through reduced wealth); net impact depends on substitution vs. income effects (Li, 2009).
- No-trade zone and holding periods:
  - Transaction costs create a “no trade zone” around the optimal portfolio; investors do not rebalance if net gains are less than transaction costs (Constantinides, 1986).
  - Transaction costs suppress short-term trading more than long-term trading because benefits of rebalancing accrue more over longer periods.
- Interaction with capital gains tax (CGT):
  - CGT “lock-in effect” increases with holding period; STT lock-in effect tends to diminish with holding period and deters trading irrespective of gains/losses.
  - Higher transaction costs increase the lock-in effect of a CGT (Dammon and Spatt, 1996).
- Risk-taking:
  - STTs discourage risk-taking by imposing costs on both good and bad realizations, reducing average demand for risky assets among risk-averse investors (Constantinides, 1986).

### IV. THE ECONOMICS OF SECURITIES TRANSACTION TAXES — C. Asset Valuation and Cost of Capital
- Theoretical and empirical consensus:
  - Higher transaction costs, including STTs, are associated with lower asset prices (Kupiecs, 1996; McCrae, 2002).
  - Liquidity premium material: illiquid privately held companies valued at 20–25 percent less than comparable publicly traded firms (Block, 2007).
- Model summary (Appendix A reference):
  - For an ad valorem STT rate T, holding period N, discount rate r, dividend growth g, and R = r - g, the proportional reduction in value, ∆, increases in T (at a decreasing rate) and decreases in N and R.
  - Effect on cost of capital approximates an increase in the discount rate of T/N.
- Illustrative examples and empirical magnitudes:
  - Very short holding periods (e.g., one day): an STT at one basis point reduces securities value by almost half.
  - Very long holding periods (e.g., 10 years): a 50 basis point STT reduces value by 1.4 percent.
  - Average holding period for S&P 500 stocks in 2009: 0.4 years (about 3.5 months); average holding period in 1990: 1.8 years (Datastream).
  - For stocks with a 0.4 year holding period:
    - A one basis point STT would reduce market value by 0.8 percent and increase cost of capital by about 3 basis points.
    - A 10 basis point STT would reduce market value by 7.6 percent and increase cost of capital by about 25 basis points.
  - For smaller capitalization stocks (wider bid-ask spreads, longer holding periods) impacts would be less.
  - Since corporate bonds trade less frequently than stocks, the impact of a given STT on corporate borrowing costs is likely smaller; a low-rate (5 basis points or less) STT likely has a modest overall impact on corporate cost of capital.
- Table 4 — Percentage reduction in security value due to an STT (R = 0.03)
  - Average Holding Period (Years) = 1; Tax Rate (T), Basis Points:
    - 0.10 -> 3.2%
    - 0.25 -> 1.3%
    - 0.5  -> 0.7%
    - 1    -> 0.3%
    - 2    -> 0.2%
    - 3    -> 0.1%
    - 3.7  -> 0.1%
    - 10   -> 0.0%
  - Average Holding Period (Years) = 5; Tax Rate (T), Basis Points:
    - 0.10 -> 14.3%
    - 0.25 -> 6.2%
    - 0.5  -> 3.2%
    - 1    -> 1.6%
    - 2    -> 0.8%
    - 3    -> 0.5%
    - 3.7  -> 0.4%
    - 10   -> 0.1%
  - Average Holding Period (Years) = 10; Tax Rate (T), Basis Points:
    - 0.10 -> 25.0%
    - 0.25 -> 11.7%
    - 0.5  -> 6.2%
    - 1    -> 3.2%
    - 2    -> 1.6%
    - 3    -> 1.1%
    - 3.7  -> 0.8%
    - 10   -> 0.3%
  - Average Holding Period (Years) = 25; Tax Rate (T), Basis Points:
    - 0.10 -> 45.4%
    - 0.25 -> 24.9%
    - 0.5  -> 14.2%
    - 1    -> 7.6%
    - 2    -> 3.9%
    - 3    -> 2.6%
    - 3.7  -> 2.1%
    - 10   -> 0.7%
  - Average Holding Period (Years) = 50; Tax Rate (T), Basis Points:
    - 0.10 -> 62.5%
    - 0.25 -> 39.9%
    - 0.5  -> 24.9%
    - 1    -> 14.1%
    - 2    -> 7.5%
    - 3    -> 5.0%
    - 3.7  -> 4.1%
    - 10   -> 1.4%
- Table 4 — Increase in Cost of Capital — Percentage Points (R = 0.03)
  - Average Holding Period (Years) = 1; Tax Rate (T), Basis Points:
    - 0.10 -> 0.10
    - 0.25 -> 0.04
    - 0.5  -> 0.02
    - 1    -> 0.01
    - 2    -> 0.01
    - 3    -> 0.00
    - 3.7  -> 0.00
    - 10   -> 0.00
  - Average Holding Period (Years) = 5; Tax Rate (T), Basis Points:
    - 0.10 -> 0.50
    - 0.25 -> 0.20
    - 0.5  -> 0.10
    - 1    -> 0.05
    - 2    -> 0.03
    - 3    -> 0.02
    - 3.7  -> 0.01
    - 10   -> 0.01
  - Average Holding Period (Years) = 10; Tax Rate (T), Basis Points:
    - 0.10 -> 1.00
    - 0.25 -> 0.40
    - 0.5  -> 0.20
    - 1    -> 0.10
    - 2    -> 0.05
    - 3    -> 0.03
    - 3.7  -> 0.03
    - 10   -> 0.01
  - Average Holding Period (Years) = 25; Tax Rate (T), Basis Points:
    - 0.10 -> 2.50
    - 0.25 -> 1.00
    - 0.5  -> 0.50
    - 1    -> 0.25
    - 2    -> 0.13
    - 3    -> 0.08
    - 3.7  -> 0.07
    - 10   -> 0.03
  - Average Holding Period (Years) = 50; Tax Rate (T), Basis Points:
    - 0.10 -> 5.00
    - 0.25 -> 2.00
    - 0.5  -> 1.00
    - 1    -> 0.50
    - 2    -> 0.25
    - 3    -> 0.17
    - 3.7  -> 0.14
    - 10   -> 0.05
- Empirical evidence:
  - Umlauf (1993): the 1983 imposition of a one percent tax on equity trades in Sweden resulted in a market decline of about 5.3 percent on the Stockholm stock exchange in the 30 days leading up to the tax.

*Source: IMF Working Paper content (IV. The Economics of Securities Transaction Taxes, Sections A–C, including Table 4).*

### introduction of the tax. Hu (1998), studying 14 separate STT changes in Hong Kong, Japan,

### _wp1154 - introduction of the tax. Hu (1998), studying 14 separate STT changes in Hong Kong, Japan,

### Impact on cost of capital and share prices
- Hu (1998), studying 14 separate STT changes in Hong Kong, Japan, Korea, and Taiwan during 1975–1994, finds that on average, a 23 percent rise in transaction costs (including the tax rate) causes an immediate one percent decline in daily market returns.
- Schwert and Seguin (1993) estimate that imposition of a 0.5 percent STT in the U.S. would increase the cost of capital by between 10 and 180 basis points.
- Oxera (2007) estimates that abolition of the 0.5 percent U.K. stamp duty would increase share prices by 7.2 percent and reduce the cost of capital by between 66 and 80 basis points.
- The impact of an STT on a company’s cost of capital depends positively on the frequency with which its shares are traded:
  - Bond and others (2004) find that the 50 percent cut in Britain’s Stamp Duty enacted in 1986 increased share prices, particularly for shares with high turnover rates, and predict that eliminating the remaining 50 basis point stamp duty would increase share prices between 2.5 and 6.3 percent, depending negatively on dividend yield and positively on market turnover.
  - Auten and Matheson (2010) find preliminary evidence that the low-rate (less than 0.5 basis points) transaction fee levied by the U.S. Securities and Exchange Commission reduces trading in only the largest, most liquid U.S. equities.
- Amihud and Mendelson’s (2000) finding of liquidity clienteles is corroborated: investors with longer (shorter) time horizons specialize in trading less (more) liquid assets. STTs are therefore capitalized more heavily into the prices of assets with high turnover, such as large-capitalization stocks.

### Turnover, liquidity, and price discovery
- STTs reduce trading volume because they render some trades unprofitable.
- Reduced trading volume generally reduces liquidity, defined as the price impact from a given trade (Amihud and Mendelson, 1986 and 1992; Kupiecs, 1996).
- Lower liquidity can slow price discovery, the process by which financial markets incorporate the effect of new information into asset prices (Froot and Perold, 1995; Frino and West, 2003).
- Models showing ambiguous effects:
  - Subrahmanyam (1998) and Dupont and Lee (2007) present models where the impact of an STT on liquidity may be either positive or negative, depending on market microstructure.
- Empirical elasticities of trading volume with respect to transaction costs:
  - Where elasticity is measured with respect to a subcomponent of transaction costs (such as STT or bid-ask spreads), the implied elasticity with respect to total transaction costs (TTC) will be higher.
  - Stock market trading volume elasticities generally range between -0.5 and -1.7.
    - Jackson and O’Donnell (1985): short-run trading volume elasticity of -0.5 and long-run elasticity of -1.7 for the U.K.
    - Umlauf (1992): a 100 percent increase in the Swedish STT in 1986 resulted in a 60 percent fall in trading of the 11 most actively traded stocks on the Stockholm exchange.
    - Lindgren and Westlund (1990): overall transaction cost elasticity of -0.85 to -1.35 for Sweden.
    - Baltagi and others (2006): the 1997 increase in China’s STT from 0.3 to 0.5 percent reduced trading volume by one-third, implying an elasticity of -0.5 with respect to the tax and an elasticity of about -1 with respect to total transaction costs.
    - Liu (2007): trading volume elasticity of -1 with respect to Japan’s STT on stocks.
    - Hu (1998): one study finding no impact of an STT on stock trading, inferring that tight regulation of most Asian markets during the period limited the potential for trade to migrate toward (untaxed) overseas markets.
- Table 5 summary (Estimated Elasticities of Trading Volume with Respect to Transaction Costs) — selected entries preserved exactly:
  - Baltagi et al. (2006) | China | Stock market | -1 | TTC
  - China | Stock market | -0.5 | STT
  - Chou and Wang (2006) | Taiwan | Futures market | -1 | STT
  - Taiwan | Futures market | -0.6 to -0.8 | BAS
  - Ericsson and Lindgren (1992) | Multinational | Stock markets | -1.2 to -1.5 | TTC
  - Hu (1998) | Multinational | Stock markets | 0 | STT
  - Jackson and O'Donnell (1985) | UK | Stock market | -0.5 (-1.7)* | TTC
  - Lindgren and Westlund (1990) | Sweden | Stock market | -0.9 to -1.4 | TTC
  - Schmidt (2007) | Multinational | Foreign exchange | -0.4 | BAS
  - Wang et al. (1997) | United States | S&P 500 Index Futures (CME) | -2 | BAS
  - United States | T-bond futures (CBT) | -1.2 | BAS
  - United States | DM futures (CME) | -2.7 | BAS
  - United States | Wheat futures (CBT) | -0.1 | BAS
  - United States | Soybean futures (CBT) | -0.2 | BAS
  - United States | Copper futures (COMEX) | -2.3 | BAS
  - United States | Gold Futures (Comex) | -2.6 | BAS
  - Wang and Yau (2000) | United States | S&P 500 Index Futures (CME) | -0.8 (-1.23)* | BAS
  - United States | DM futures (CME) | -1.3 (2.1) | BAS
  - United States | Silver futures (CME) | -0.9 (1.6) | BAS
  - United States | Gold futures (CME) | -1.3 (1.9) | BAS
  - Notes: *Long-run elasticities in parentheses. TTC = Total Transaction Costs. STT= Security Transaction Tax. BAS = Bid-Ask Spread.
- Other markets:
  - Fixed-income markets: Froot and Campbell (1994) find Sweden’s imposition of a 0.2 to 3 basis point STT on bonds produced a sharp drop in trading volume; long-term bond trading fell 85 percent upon announcement of the tax, bill volume fell 20 percent.
  - Foreign exchange: Schmidt (2007) estimates the elasticity of foreign exchange trading with respect to transaction costs for a multilateral tax on the four largest trading currencies at -0.4. This relatively low elasticity reflects the broad multilateral base, reducing opportunities for avoidance.
  - Futures markets: Wang and others (1997) and Wang and Yau (2000) find a negative relationship between bid-ask spreads and trading volume in seven U.S. futures markets, and estimate long-run elasticities to exceed short-run elasticities.
  - Chou and Wang (2006): a 50 percent reduction in Taiwan’s STT on futures markets resulted in a commensurate increase in trading volume, controlling separately for changes in the bid-ask spread.
- Reallocation and migration of trades:
  - Umlauf (1993) and Froot and Campbell (1994): Swedish STT resulted in massive migration of trading in Swedish stocks from Stockholm to London.
  - Froot and Campbell: Swedish tax shifted fixed-income trading activity within Sweden to untaxed substitutes (corporate loans, variable-rate notes, forward rate agreements, swaps).
  - Chou and Wang (2006): reduction of the STT on Taiwanese futures markets induced migration of trade from Singapore to Taiwan.
  - These findings highlight the importance of STT design (rate and base) to effectiveness and administrability.

- Price discovery and autocorrelation:
  - Studies examine changes in autocorrelation of market returns following STT changes.
  - Liu (2007): reduction of Japanese STT in 1989 reduced the first order autocorrelation observed in Japanese stock price changes, aligning autocorrelation with that of untaxed Japanese depository receipts trading on the U.S. stock market.
  - Baltagi and others (2006): an increase in China’s STT rate increases the autocorrelation of returns.

### Market dynamics, transaction costs, and efficiency
- Policy rationale for a broad-based STT:
  - Adopted to curb perceived negative externalities: growth in short-term securities and derivatives trading, most of which is viewed as speculative noise-trading that promotes excess volatility and asset bubbles (Schulmeister and others, 2008).
  - By raising transaction costs, an STT is intended to curb short-term trading, reduce volatility and asset mispricing, and discourage zero-sum speculative trading deemed to add no real value.
- Decline in transaction costs and rise in trading:
  - Commission deregulation (1975) and decimalization (2000) substantially lowered transaction costs in the U.S. equity market.
  - Bid/ask spreads on the NYSE now average about 0.1 percent (Jiang, and others, 2009), vs. 1.3 percent in the mid-1980s (Clark, and others, 1992).
  - In foreign exchange markets, bid-ask spreads for major currencies are currently as little as 1–4 basis points, half the level of a decade ago.
  - Spreads in interest rate futures and swaps are on the order of a few basis points.
  - Development of interest rate and credit default swap markets has enabled cheaper tailoring of fixed-income exposure than trading underlying bonds.
- Financial transactions relative to real activity:
  - The value of world financial transactions was 25 times world GDP in 1995 and rose to70 times that value by 2007 (European Parliament, 2010).
  - Growth concentrated in derivatives markets, which often have much lower transaction costs relative to notional values than spot markets.
  - Growth in interest rate and equity derivatives transactions has far outstripped growth in business investment in North America and Europe, while the ratio of spot transactions to investment has remained fairly steady (Schulmeister and others, 2008).
- Algorithmic and high-frequency trading (HFT):
  - Algorithm trading accounted for at least 60 percent of U.S. equity trading volume in 2009 (up from about 30 percent in 2006), and 30–40 percent of European and Japanese equity trading.
  - Algorithm trading accounts for 10–20 percent of foreign exchange trading volume, 20 percent of U.S. options volume, and 40 percent of U.S. futures volume (Reuters, 2009).
  - Much algorithm trading provides best execution for institutional orders; a significant portion is HFT with very short-term intraday horizons.
  - Concerns: risk of market dislocation from technical malfunction or cascading correlated trades, greater herding behavior, and increased leverage via derivatives that raises liquidity and default risk and may promote asset bubbles (Allen and Gale, 2000).
  - Historical examples include the October 1987 crash and the May 2010 “flash crash.”

### Volatility: short-term vs long-term price swings
- Two types of volatility possibly affected by STTs:
  - Short-term price volatility.
  - Long-term asset price swings (bubbles and crashes) with larger macroeconomic externalities.
- Theoretical ambiguity:
  - If an STT reduces trading volume, it may decrease liquidity (increase price impact), tending to heighten volatility.
  - STT may reduce activity by noise traders (potentially stabilizing) but may also suppress informed traders and arbitrageurs (potentially destabilizing or slowing price convergence to fundamentals).
  - Noise traders contribute to liquidity; removing them has a double-edged effect.
  - Models and empirical studies show volatility may either rise or fall upon introduction of an STT (Song and Zhang, 2005; Pellizzari and Westerhoff, 2007).

*Source: content unit _wp1154 - introduction of the tax. Hu (1998), studying 14 separate STT changes in Hong Kong, Japan,*

### introduction of an STT, depending on the market microstructure. This inability of an STT to

### _wp1154 - introduction of an STT, depending on the market microstructure. This inability of an STT to

### Impact on short-term volatility and trading activity
- Theoretical models cannot resolve the impact of securities transaction taxes (STTs) on short-term volatility; the question is left to empirical investigation.
- Empirical findings:
  - Many studies consider short-term price volatility rather than long-term mispricing and show either no effect of transaction costs on volatility or a positive effect.
  - Roll (1989): finds no consistent relationship between transaction costs and volatility across 23 countries.
  - Baltagi, and others (2006): find no impact of China’s STT increase on volatility.
  - Jones and Seguin (1997): U.S. stock commission deregulation that reduced transaction costs led to decreased price volatility.
  - Hau (2006): tick-size reduction in France led to a fall in volatility.
  - Green and others (2000): increases in the U.K. stamp duty generally lead to higher short-term price volatility.
- Trading itself generates short-term volatility:
  - French and Roll (1986) and Barclay, and others (1990) show price volatility is higher during trading sessions than between them, controlling for new information, implying trading generates a significant portion of short-term volatility.
  - Therefore, a transactions tax that depresses trading activity could reduce that source of short-term price volatility.
- Relationship to bubbles and crashes:
  - Literature attributes bubbles and crashes mainly to leverage cycles (e.g., Allen and Gale, 2000; Reinhart and Rogoff, 2009; Akerlof and Shiller, 2008).
  - High transaction costs in real estate markets (several percentage points) coexist with frequent bubbles, suggesting a low-rate STT will not prevent asset bubbles.
  - An STT could slow both asset upswing and price corrections; discouraging leverage directly (e.g., via higher margin requirements) is a more direct policy to counter bubbles.
- Leverage and derivatives:
  - Taxing derivatives or leveraged trades on the notional value would raise the effective tax rate with leverage, discouraging leverage.

### Market microstructure, technical trading, and algorithmic trading
- Short-term trading can induce herding and departures from fundamentals (Froot, and others, 1992).
- Technical analysis is prevalent in short-term trading (Gehrig and Menkhoff, 2007), but includes both momentum and contrarian strategies.
- Experimental and empirical results:
  - Bloomfield, and others (2009): uninformed “noise” traders act as contrarians, increase liquidity, but deter price discovery; a transactions tax reduces trading by both noise and informed traders and does not improve pricing efficiency.
  - Chaboud and others (2009): algorithmic trades in FX (2006–07) are more correlated but do not increase price volatility.
- Policy implication: STTs do not reliably distinguish between stabilizing and destabilizing trades; this inability is a principal reason for rejection by many analysts.

### Efficiency, “waste,” and liquidity valuation
- Critics view short-term trading as a social waste; proponents contend liquidity and price discovery add value even at current trading levels.
- Empirical valuation of liquidity:
  - Investors accept lower returns for more liquid securities (Amihud and Mendelson, 2005).
  - Emerging markets seeking financial development should be wary of introducing an STT.
- Non-pecuniary motives for trading and consumption value:
  - Hedgers accept losses for risk reduction.
  - Retail investors trade excessively, lowering returns (Barber and Odean, 1998, 1999); motives may include overconfidence or consumption-like utility from trading activities.

### Incidence and distributional effects
- Immediate burden:
  - Owners of traded securities at the time of STT introduction would bear a large part of the burden via an immediate fall in prices equal to the present value of expected future STT liabilities.
  - Distributional consequence: the effect is likely highly progressive because high-income individuals hold a disproportionate share of financial assets.
  - U.S. 2007 holdings (Table 6 examples):
    - Top decile by income owned 81 percent of bonds, 63 percent of stocks, 57 percent of investment funds, and 56 percent of retirement account assets.
    - At least 52 percent of these four asset groups are held by taxpayers 55 and older.
    - At least 88 percent are held by taxpayers 45 and older.
- Long-run incidence:
  - Market forces tend to equalize after-tax returns across taxed and untaxed capital; effect depends on capital mobility:
    - Small open economy: capital flows out until after-tax return restores to world market level; burden falls on workers via lower wages.
    - If capital supply is less than perfectly elastic: burden shared between capital owners and workers.
- Sectoral impacts:
  - Financial firms’ dealing, trading, and underwriting profits would contract; sector could employ fewer resources and compensation for highly skilled workers could decline.
  - STTs are more distortive than taxes on net income or value added because they tax gross transaction values and cascade through production.
  - STT disproportionately burdens sectors that issue/trade securities heavily: financial sector, pension funds, public corporations, international commerce firms, and public entities (if government bonds taxed).
- Cascading and multiple layering:
  - Because transaction taxes are not creditable, even a low-rate STT may impose a high effective burden on certain activities through cascading.

### Alternatives to an STT (for curbing excesses and raising revenue)
- Regulatory and tax alternatives to discourage excessive leverage or raise revenue:
  - Increase margin/collateral requirements to discourage leveraged purchases.
  - Tax on balance sheet debt (net of insured deposits and equity), such as the financial sector contribution (FSC) (IMF, 2010), potentially tailored to systemically important institutions.
  - Corporate income tax reform to reduce debt bias: reduce or eliminate interest deductibility; or introduce an allowance for corporate equity (ACE) with corresponding reduction in interest deductibility.
  - Apply transactions tax on full notional value of leveraged transactions to discourage leverage at transaction level.
- Raising revenue from financial sector:
  - Improve VAT application to financial services (extend VAT to fee-based financial services; systems to apply VAT to bank interest margins have been developed but not implemented).
  - Financial activities tax (FAT) on net value added or on compensation and profits above a threshold to tax financial sector rents; less distortive per revenue raised than an FTT because FAT taxes net value added rather than gross transaction value.
- STT as second-best regulation:
  - European Parliament (2010) views a low-level STT as a provisional second-best measure where regulatory regimes are imperfect, to slow potentially explosive financial activity until better regulation/taxes are implemented.
  - However, STT does not directly address systemic risk nor product-innovation-driven complexity which were central to recent crises.

### STT design: major considerations
- Broad principles:
  - Broader tax base across instrument types and potential substitutes reduces revenue erosion and allows a lower rate for a given revenue target.
  - Taxing both debt and equity reduces distortion of financing decisions.
  - It is not possible to impose identical tax burdens on economically equivalent contracts due to varied transactional intensity (e.g., put-call parity implications).
  - Practical considerations (taxing readily identifiable quantities) must complement arbitrage considerations.

- Tax base: instruments and scope
  - Recommended coverage: transactions in all types of traded securities—equity, debt, foreign exchange—and their derivatives to prevent migration of trading to untaxed substitutes.
  - Taxing public sector debt is controversial: raises government borrowing costs and may generate net fiscal loss; failing to tax public bonds may draw liquidity away from private bond market.
  - Derivatives:
    - Futures/forwards: cannot use initial market value (zero); can tax on spot price or delivery price (U.K. and India tax equity futures on delivery price).
    - Swaps: could be taxed on notional value; swaps represent 100 percent leveraged investment and in theory should be taxed at twice the rate of underlying trades; anti-abuse rules needed to prevent artificial notional shrinkage by multiplying cash flows and dividing notional by the same factor.
    - Options: possible tax bases include premium (initial market value), strike price if executed, spot value of underlying at time of transaction; taxing options on full notional penalizes leverage.
  - Practical examples and observations:
    - U.K. CFDs expanded in part due to exemption from stamp duty; in 2009 CFDs accounted for 40 percent of trading on the London Stock Exchange (City Credit Capital, 2010).
    - Brazilian foreign exchange tax spurred creation of untaxed cash-settled futures market large relative to the taxed spot market.
  - Trades in pass-through entities and pooled funds:
    - Trades in investment trusts should be taxable to prevent avoidance; taxation design must address double taxation vs avoidance risks when funds actively trade.
  - Exchange-traded vs OTC:
    - Most STTs apply to exchange-traded securities cleared through central clearing houses (easier administration).
    - Exempting OTC incentivizes migration to OTC, reducing transparency.
    - Taxing OTC is administratively harder (reporting by financial institutions rather than remittance through clearing houses); higher STT rates on OTC could incentivize exchange trading but increase compliance costs.
  - Territoriality and entity status:
    - Tax designers must choose territorial rules (location of trade, nationality of transactors, nationality of issuer) with implications for evasion and administration.
    - Intermediary relief (e.g., U.K. market-maker relief) reduces cascading but may invite avoidance; taxing financial institutions on trades for their own account is preferable where feasible.

- Tax rate structure and calibration
  - Rate choices: ad valorem vs flat fees:
    - Most STTs are ad valorem based on value traded; some flat-fee examples:
      - New York State tax: up to five cents per share on within-state stock trades with a cap of $350 per trade.
      - 1993 U.S. proposal: fixed 14-cent tax on trades of futures and options on futures.
    - Fixed-rate STTs tax small trades relatively more, encouraging order aggregation and countering “order shredding”.
  - Relationship to pretax transaction costs and externalities:
    - Applying identical STT rates across markets with differing pretax transaction costs raises total transaction costs proportionately more in low-cost markets.
    - Example: India taxes stock option premiums and futures prices at lower rates than stocks (1.7 basis points vs 12.5 basis points).
    - Policymakers may nonetheless apply higher rates to derivatives and/or OTC markets if leverage or opacity is considered socially costly.
  - Maturity and time-dimension effects:
    - Uniform STT on issuance can distort maturity choices: one ten-year bond paying ten times less tax than ten one-year bonds with same principal could induce longer maturities.
    - Responses have included setting lower rates on short-term paper (e.g., Sweden) or multiplying base rates by years to maturity (Pollin, and others, 2002).
  - Illustration of option taxation regimes:
    - Figure 1 (hypothetical) compares STT revenue under different regimes with an STT rate of one percent for three transactions: (1) spot trade of stock purchased at $100 and sold; (2) purchase and sale of at-the-money one-year option; (3) purchase and subsequent exercise of at-the-money option.
    - Key observation: taxing options on underlying value imposes heavier burden than taxing option cash flows; option premium-and-strike taxation is essentially step-function conditioned on exercise.

- Administrative and avoidance considerations
  - Use administrative handles such as share registration or contract recognition to ensure compliance.
  - Centralized clearance mechanisms can reduce collection costs:
    - U.K. stamp duty collection via CREST: cost 0.09 pence per pound sterling to collect, vs. all-tax average cost of 1.11 pence.
  - Avoid defining base in relation to a particular market structure given rapid product and platform innovation.
  - Historical lessons:
    - Swedish equity transaction tax (1984–1991) taxed trades through registered Swedish brokers and was easily avoided by using non-Swedish brokers, leading to migration to London.
    - U.K. stamp duty is a tax on registration of shares in U.K.-registered companies, reducing incentive to migrate trading offshore.

- Empirical market changes and implications
  - U.S. bond market turnover fell from 8.5 times per year in 2005 to 5.9 times per year in 2009 as trading migrated from bonds to credit and interest rate swaps.
  - Many derivatives, particularly OTC products, do not trade actively; STTs should cover initial issuance as well as subsequent trades.

### Multilateralism and revenue allocation
- Unilateral STTs are feasible; several major financial centers (U.K., Switzerland, Hong Kong, Singapore, South Africa) levy forms of STTs without necessarily driving out financial activity.
- Multilateral coordination:
  - Coordinated STT adoption would reduce base elasticity and enhance revenue collection; governance issues (authority over rate and base) are challenging.
  - Revenue apportionment under a multinational STT: host countries of major financial centers (e.g., U.K.) would raise more revenue; allocation could be based on member GDP or total use of financial services.

*Source: IMF working paper content provided in the supplied PDF excerpt.*

### Box 2. The United Kingdom Stamp Duty

### Box 2. The United Kingdom Stamp Duty

### Overview and revenue performance
- The U.K. Stamp Duty is frequently regarded as a successful STT because it consistently raises a fair amount of revenue—an average of £3.3 billion per year, or almost 0.3 percent of GDP, since 2000.
- Collection of the stamp duty reserve tax on electronic share transactions via the CREST automated clearing system makes the tax very cost-efficient to administer.
- Footnote: Revenue figures are for Stamp Duty on shares only, i.e., they do not include revenue from real estate transactions.

### Tax design, base, and effective burden
- The statutory rate often cited is 0.5 percent; because the tax base is gross transaction value rather than value added or net income, 50 basis points is effectively very high.
- Institutional non-tax transaction costs for share trading (a measure of transactional value added) average about 25 basis points; a 50 basis point STT therefore triples total transaction costs for such trades.
- Retail transaction costs are generally higher; Stamp Duty raises them proportionately less but still imposes a substantial increase.
- Due to intermediary relief and exemptions, the tax is likely to fall most heavily on longer-term, risk-averse investors.

### Exemptions, avoidance channels, and incentives
- Exemption of equity derivatives that do not result in share purchases is logically consistent with taxing transfers of rights in registered property, but taxing shares while exempting close substitutes creates an incentive for investors to seek equity exposure through derivatives, thereby increasing financial leverage and risk.
- Logical exemptions to avoid tax cascading include intermediate share purchases by financial firms; however, proprietary trading arguably should be taxed.
- Charities are exempt; pension funds and hedge funds are not. As a result:
  - Some institutional investors can avoid stamp duty due to intermediary relief.
  - Short-term investors willing to incur increased risk may avoid it by trading in derivatives.
- Oxera (2006) estimates that only about 20 percent of share trading on the London Stock Exchange is subject to stamp duty due to various exemptions.

### Geographic neutrality and anti-avoidance measures
- Two features reduce geographic distortion:
  - The duty applies to trades in U.K.-registered shares regardless of where in the world they take place.
  - It does not apply to shares of foreign corporations listed in London (unless the corporation establishes a U.K. share registry).
- Previously, avoidance via foreign depository receipts and holding in clearance service (“street name”) accounts reduced the tax base. To combat this, a higher-rate “season ticket” charge of 1.5 percent was imposed on equity committed to these schemes beginning in 1986.
- Clearance service accounts: investors buy and sell rights to shares owned and registered to a third party financial institution; purchase and sale of these rights therefore does not by itself trigger stamp duty.

### Empirical and quantitative findings (from broader analysis)
- Current estimates of the revenue potential of a low-rate (0.5–1 basis point) multilateral CTT on the four major trading currencies suggest it could raise about $20–40 billion annually, or roughly 0.05 percent of world GDP.
- A one basis point STT on global stocks, bonds and derivatives is estimated to raise approximately 0.4 percent of world GDP.
- Studies suggest the elasticity of trading volume with respect to transactions costs ranges broadly between -0.4 and -2.6, depending on the market; markets with more untaxed substitutes have higher elasticities.
- The average transaction cost for ordinary corporate equity trades in major financial centers is about 25 basis points.
- Example estimate: If an STT of 2 basis points reduced turnover on the S&P 500 to the average level of 2005 (0.8 years), it would initially lower stock values by roughly 1 percent and raise the cost of capital by 3 basis points.
- SIFMA data indicate that the average holding period for corporate bonds in 2009 was 1.6 years.

### Economic effects and efficiency considerations
- STTs reduce security values and raise the cost of capital for issuers, particularly for frequently traded securities.
- STTs reduce trading volume, which in turn reduces liquidity and slows price discovery.
- There is no convincing evidence that STTs lower short-term price volatility; high transaction costs are likely to increase volatility.
- Asset bubbles are currently attributed mainly to excessive leverage rather than excessive transactions per se; taxing derivatives could discourage leverage indirectly, but instruments that explicitly target leverage (for example, higher margin and collateral requirements) address leverage more directly.
- Short-run incidence of an STT is likely to be progressive: securities values fall, financial activity contracts, and financial sector profits decline. Financial firms would likely pass surviving costs to clients, including charities and pension and mutual funds.
- In the medium term, resource release from the financial sector could lower equilibrium returns to highly skilled labor.
- In the long run, the burden of an STT depends on the elasticity of capital supply; as capital supply elasticity increases, higher financing costs imposed by an STT will fall more heavily on labor than on capital owners.

### Policy recommendations and best-practice design lessons
- Consider more efficient alternatives before adopting an STT. Options include:
  - Reducing the debt bias from corporate income taxation to discourage excessive leverage.
  - Introducing a tax on balance-sheet debt such as the FSC.
  - Broadening the base of an existing VAT to include fee-based financial services, or introducing an FAT to tax the financial sector.
- If a country nevertheless seeks significant revenue from an STT:
  - Apply a low-rate tax to all securities and derivatives transactions, including OTC transactions, to minimize distortions.
  - A broad-based STT is harder to avoid than a narrow-based tax, although any STT base is vulnerable to erosion over time through financial innovation and international integration.
  - Multilateral STTs have less elastic bases than national STTs, so a given revenue target can be achieved with a lower rate.
  - It is difficult to justify a tax solely on foreign exchange transactions: it would raise much less revenue on a considerably more elastic base, and the OTC nature of currency markets would complicate administration.
- Note on scope: Imposition of even a low-rate STT on high-frequency-traded securities and narrow-margin markets (such as currencies and futures) would reduce trading volume more dramatically; given the secular decline in non-tax transaction costs, the relative impact of an STT on total transaction costs will tend to increase over time.

*Source: Box 2. The United Kingdom Stamp Duty, _wp1154*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/wp/2011/_wp1154.pdf_