That may no longer be the case. The financial industry is on the warpath against a financial transaction tax in Europe. The proposed tax would be 0.1 percent on stock trades (one fifth the size of the tax that has been in place for centuries in the United Kingdom) and 0.01 percent on transfers on most of options, futures, and most other derivatives.
Since the price of trading has plummetted over the last four decades due to developments in computer technology, this tax would just raise trading costs back to where they were ten or twenty years ago. That would not seem to be too horrible on its face, since Europe certainly had a well-developed and active capital market in 2000 or even 1990.
But the financial industry needs to scare people in order to discourage Europe from going the route of the tax. So it put out a study that calculated the cost of the tax to some active traders on the assumption that no one changes their behavior in response to the tax. This is of course absurd since part of the point of the tax is to reduce trading by raising the cost. The frequent flipping of assets provides no net gain to the economy, even if it can provide some individuals and corporations with large profits.
In reality, frequent traders would cut back their trading a huge amount if the cost were to rise as a result of this tax. There is considerable research on the response of trading to changes in costs or elasticity. Most find that trading is relatively elastic. In fact some research, such as this analysis published by CATO, found that the elasticity of trading for many types of assets is greater than 1. This means that the percentage reduction in the volume of trading is larger than the percentage increase in costs.
In that case when the cost of trading goes up, as a result of a financial transactions tax or for any other reason, people will on average actually spend less on trading. They will cut back their trading by enough so that even though they pay more on each trade, they spend less in total on trading. This is a simple story. If the cost per trade doubles, but people reduce their trading by 60 percent, then they will spend less money on trading.
The financial industry's study completely ignored both the most basic principle in economics (demand responds to changes in price) and the extensive research on the elasticity of trading. It assumed that no one reduces their trading in response to the tax. This would be like calculating the cost of a tax on e-mails, under the assumption that the volume of e-mail messages would not change.
It is understandable that the financial industry would try to push out a study like this. After all, a financial transactions tax is money right out of their pockets. They will spend a fortune lobbying, buying politicians or doing whatever is necessary to keep such taxes from going into effect.
But the key question is why would the Wall Street Journal write up such an obvious joke as a serious study in its news section? That's the question millions are asking.
Original article on Center For Economic And Policy Research