Taxing Financial Transactions
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Husted, Elisabeth Reventlov1, Forfatter
Sørensen, Peter Birch2, Vejleder
1Det Samfundsvidenskabelige Fakultet, Københavns Universitet, København, Danmark, diskurs:7001              
2Økonomisk Institut, Det Samfundsvidenskabelige Fakultet, Københavns Universitet, København, Danmark, diskurs:7014              
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Ukontrollerede emneord: Tobin tax, FTT
 Abstract: More than forty years ago, the American economist and Nobel Prize winner James Tobin suggested a tax on currency transactions with the intention that its introduction would limit short-term speculation in exchange markets. The general financial transactions tax discussed in recent years is often referred to as the Tobin tax. The tax is however somewhat different in form and scope, the tax aim to tax all types of financial transactions, but the intention behind introducing the tax remain equivalent to Tobin’s – the desire to curb short-term speculation in order to reduce non-fundamental volatility in financial markets.

This thesis is motivated by the discussion above and seeks initially to investigate whether introducing a tax on transactions leads to the asserted reduction in price volatility and thereby evaluate whether this is a valid argument for taxing financial transactions within the cooperation of the European Union.

The controversy about taxing financial transactions has several opposing arguments against and in favour of introducing the tax. The strongest objection against a tax on financial transactions is that it might impose long-term distorting effects on real economic activity. While the main argument in favour of the tax, is its potential to possibly reduce non-fundamental volatility in asset prices and real economic variables. The “volatility-reduction argument” rests on the assumption that the tax will curb the speculative short-term trading behaviour of a specific type of traders.

Joseph E. Stiglitz introduced the concept of “noise traders” in his paper “Using Tax Policy To Curb Short-Term Trading” from 1989. Noise traders have faulty expectations, as they believe that they can do better than the market, they base their trading decision on non-fundamental information. Noise traders’ transactions thereby add “noise” to market signals and hence increase non-fundamental volatility in markets. By introducing a transactional tax the noise traders’ ex ante expectations are corrected. Hence should the tax succeed in curbing the noise traders’ non-fundamental trades, it will therefore reduce asset mispricing and decrease price volatility. Reducing non-fundamental price volatility in financial markets is preferable, as it secures a stable investment environment.

The effects of introducing a transactional tax, is examined in a dynamic stochastic general-equilibrium (DSGE) model, as set up in the paper “Securities Transaction Taxes: Macroeconomic Implications in a General-Equilibrium Model” by Julie Lendvai, Rafal Raciborski and Lukas Vogel, 2012. The DSGE model incorporates effects of noise trading and builds a framework for running a range of Solow simulations that makes it possible to compare steady-state values of a model that does include a transactional tax versus a model that does not. The transactional tax included in the model is similar to the one proposed by the European Commission and the model parameterised to reflect the European model of corporate finance.

The interpretation of the generated results are quite clear; introducing a financial transactions tax does lead to a reduction in short-term trade and hence reduces non-fundamental volatility. Whether the reduction in volatility has a positive effect on the economy, is however unclear. Comparing the simulated results does confirm that a major drawback of introducing the tax is a substantial decline in real economic variables. Considering the results, the ambiguous effect of the reduction in volatility and the substantial decline in real economic activity, the “volatility-reduction argument” alone, does not seem a valid argument for taxing financial transactions.
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Bogmærk denne post:
 Type: Speciale
Alternativ titel: Beskatning af finansielle transaktioner
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Sprog: English - eng
 Datoer: 2014-02-03
 Sider: -
 Publiceringsinfo: København : Københavns Universitet
 Indholdsfortegnelse: 1 Introduction 3
2 Financial Transactions Tax – A Theoretical Perspective . 6
Figure 2.1: Financial instruments the FTT may apply to . 7
3 Formalising the “Volatility-reduction Argument” . 8
3.1 John Maynard Keynes – Using Tax Policy to Limit Speculation . 9
3.2 James Tobin – Using Tax Policy to Avoid Exchange-rate Volatility 11
3.3 Joseph Stiglitz – Using Tax Policy to Curb Speculative Short-term Trading . 13
3.4 Stiglitz – The two Main Objections Posed by Economists . 14
3.5 Stiglitz – Curbing Short-term Speculation, Reducing Price Volatility 19
3.6 Summary & Concluding Remarks 22
4 EC Proposal – A Common System for an FTT, 2011 . 23
4.1 Design and Scope of the EC’s FTT 24
4.2 Main Objectives of the EC’s FTT 26
4.3 Summary 29
5 Automated Trading – Causing or Correcting Instabilities? . 30
5.1 The Prevalence of Automated Trading . 30
5.2 Differing Trading Strategies – Impact on Financial Stability 31
5.3 Validity of the “volatility-reduction argument” and Automated Trading 32
5.4 Summary 34
6 Testing the Argument – Fit in a Macro Model . 34
6.1 The Dynamic Stochastic General-Equilibrium Model 36
6.2 Model Description . 38
6.3 The Infinitely-lived Households . 39
6.4 The Short-term Traders . 41
6.5 Expectations of the Short-term Traders . 42
6.6 Firms’ Decision Making . 44
6.7 Government . 47
6.8 Aggregation & Equilibrium . 48
6.9 Summary & Concluding Remarks 49
7 Analysis – Interpreting the Simulated Results 50
Table 7.1: Steady-state ratios . 51
7.1 Exogenous Shocks . 51
7.2 Parameterisation – Fitting EU Financial Structures . 53
Table 7.2: Parameters in the DSGE model with noise traders and a STT 53
7.3 Analysis – The Benchmark Model . 54
Table 7.3: Impact of the STT in the Benchmark model 55
7.4 Sensitivity Analysis – Alternating model assumptions 57
Table 7.4A: Impact of the STT, stronger short-term investment horizon 57
Table 7.4B: Impact of the STT in model without long-term investment . 58
Table 7.4C: Impact of the STT in model with low share of noise traders . 59
Table 7.4D: Impact of the STT in model with high share of noise traders . 59
7.5 Summary & Concluding Remarks 60
8 Discussion – Validity of the “Volatility-reduction Argument” 60
9 Conclusion 65
10 References . 67
10.1 Books and scientific articles . 67
10.2 Official reports, statistics, etc. . 68
10.3 Other information, Homepages, articles, etc. . 68
11 Appendix . 70
Table A1: Full list of the DSGE model’s variables 70
Table A2: Full list of the DSGE model’s parameters 71
A.1 The Infinitely-lived Households’ Optimization Problem . 72
A.2 The Short-term Traders Optimization Problem . 73
A.3 The Firms Optimization Problem 74
 Note: -
 Type: Speciale
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