Journal of Financial Services Research, 3: 261-286(1989)
© 1989 KJuwer Academic Publishers
When Financial Markets Work Too Well: A Cautious
Case For a Securities Transactions Tax
LAWRENCE H. SUMMERS
Professor of Economics
Littauer 229
Harvard University
Cambridge, MA 02138
VICTORIA P. SUMMERS
Deputy Director, International Tax Program
Harvard University, Cambridge, MA 02138
Abstract
Unlike most major industrialized nations, the United States does not impose an excise tax on securities trans-
actions. This article examines the desirability and feasibility of implementating a U.S. Securities Transfer Excise
Tax (STET) directed at curbing excesses associated with short-term speculation and at raising revenue. We
conclude that strong economic efficiency arguments can be made in support of a STET that throws "sand into the
gears," in James Tobin's (1982) phrase, of our excessively well-functioning financial markets. Such a tax would
have the beneficial effects of curbing instability introduced by speculation, reducing the diversion of resources into
the financial sector of the economy, and lengthening the horizons of corporate managers. The efficiency benefits
derived from curbing speculation are likely to exceed any costs of reduced liquidity or increased costs of capital
that come from taxing financial transactions more heavily. The examples of Japan and the United Kingdom suggest
that a STET is administratively feasible and can be implemented without crippling the competitiveness of U.S.
financial markets. A STET at a .5% rate could raise revenues of at least $10 billion annually.
Technological and institutional innovations have radically transformed financial markets in
the United States and around the world. These changes have permitted and encouraged
spectacular increases in the volume of trade in securities of all kinds. In 1960, 766 million
shares were traded on the New York Stock Exchange; by 1987, more than 900 million shares
changed hands in the average week. More shares were traded on the lowest-volume day in
1987 than in any month in 1960. And more shares changed hands in the first 15 minutes
of trading on October 19 and 20, 1987, than in any week in 1960.
Increases in trading have been even more spectacular in other markets. In 1960 or 1970
there were no organized markets in derivative securities. Today, the dollar value of contracts
traded on the stock market futures market alone significantly exceeds the volume of trade
We wish to thank David Cutler, Thomas Kalil, James Poterba, Jonathan Evans, and Charles Perry for useful
discussions, and Jeffrey Mantz for dedicated research assistance.
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-^>^ SUMMERS AND SUMMERS
on the stock market itself, and the volume ol trade in stock market futures is nearly equalled
by trade in index options. Explosive increases in trading volumes have not been confined
to corporate equities. While the value of shares traded on the New York Stock Exchange
a\erages less than $10 billion a day, the daily value of trade in government bonds averages
more than $25 billion and the daily value of trade in foreign exchange approaches $300
billion. There is every reason to e.xpect trading volumes to continue to increase. Already,
the New York Stock Exchange is planning for a billion share day. And with increasing
international linkages between markets, an increasing variety of securities will soon be
tradable 24 hours a day.
In the narrow sense of permitting trade to take place between consenting adults, it is
obvious that our financial markets have become much more efficient over time. Unloading
a million dollar portfolio of stock might easily have cost $10,000 or more in 1960; today
a functionally equivalent transaction can be carried out in the futures market for a couple
of hundred dollars or less. There are, however, increasing concerns that financial markets
may have deteriorated over time in performing their social functions of spreading risk and
efficiently guiding the allocation of capital, despite their increased transactions efficiency.
On the question of risk taking. First Boston's Albert Wojnilower (1980) expressed the
fears of many in financial markets when he wrote that: "The freeing of financial markets
to pursue their casino instincts heightens the odds of crises . . . . Because unlike a casino,
the financial markets are inextricably linked with the world outside, the real economy pays
the price.'" Treasury Secretary Brady (1988) has expressed concerns about the costs of our
financial system: "We are headed in the wrong direction, when so much of our young talent
and so much of this nation's resources are aimed at financial engineering when the rest of
the world is laying the foundation for future growth." And the proposition is widely
endorsed that American business needs to be freed from market pressures that prevent it
from taking the long view.
Concern about the consequences of rapid turnover in financial markets is hardly new. In
one of the most famous chapters of The General T/ieoty, Keynes questioned the benefits
of more liquid and smoothly functioning financial markets:
As the organization of investment markets improves, the risk of the predominance of
speculation does increase. In one of the greatest investment markets in the world, namely
New York, the influence of speculation is enormous. Speculators may do no harm as
bubbles on a steady stream of enterprise. But the position is serious when enterprise
becomes the bubble on a whirlpool of speculation. When the capital development of a
country becomes the by-product of the activities of a casino, the job is likely to be
ill-done. The measure of success attained by Wall Street, regarded as an institution of
which the proper social purpose is to direct new investment into the most profitable
channels in terms of future yield cannot be claimed as one of the outstanding triumphs
of laissez-faire capitalism—which is not surprising if I am right in thinking that the best
brains of Wall Street have been in fact directed towards a different object.
He continues the same passage by suggesting a possible remedy for the problems caused
by excessive speculation:
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