Speculation and Tobin Taxes: Why Sand in the Wheels Can Increase Economic Efficiency

Abstract

The current paper develops the microeconomic case for a Tobin tax. It combines the noise-trader literature with the Tobin-tax-policy literature. Noise traders cause economic losses by inappropriately cashing out their investments. A Tobin tax can reduce such activity, thereby conferring a benefit on fundamentals investors. The paper identifies the conditions under which these gains would be largest and provides guidelines as to whether a tax is warranted. There is a trade-off because Tobin taxes discourage fundamentals investors from trading, and there are occasions when they would rationally choose to trade but do not because of the tax.