The societal benefits of a financial transaction tax

By Aleksander Berentsen, Samuel Huber and Alessandro Marchesiani

We investigate the positive and normative implications of a tax on financial market transactions in a dynamic general equilibrium model, where agents face idiosyncratic liquidity shocks and financial trading is essential. Our main finding is that agents’ portfolio choices display a pecuniary externality which results in too much trading. We calibrate the model to U.S. data and find an optimal tax rate of 2.5 percent. Imposing this tax reduces trading in financial markets by 30 percent.

It is difficult to think why a Tobin tax would make sense in a standard DSGE model. The paper above takes into account that people have two types of assets, liquid and illiquid ones. Naturally, they would like to minimize the amount of liquid assets they carry around as they typically have lower returns. The authors point out that having liquid assets provides, however, a positive externality onto the economy. One way to entice people to hold more of them is to make conversions between liquid and illiquid assets more costly, the Tobin tax. And the welfare benefit seems to be quite substantial.

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