Taxing Financial Transactions

The Obama Administration is looking for ideas in the area of taxing financial transactions. Ezra Klein asked for thoughts. Even though I haven’t read deeply into this area (*) I have an idea to share. I would not be at all surprised if it has already been proposed or considered by those more knowledgeable in this area than I am. Nevertheless, here goes:

We already tax financial transactions in a way via short- and long-term capital gains, the cutoff between the two being one year. If a policy goal is to reduce high-frequency trading I have two ideas that build on the current tax framework: (1) Include a “very short” category with, say, a cutoff of a quarter year, or month (or whatever makes sense to the folks who really know this stuff). This very short category could have, though need not have, an even higher capital gain tax rate than the current short-term one does; (2) Eliminate the ability to write off short-term (or very short-term) capital losses. Ideas (1) and (2) need not be combined.

A third idea is to remove the taxation exemption from otherwise tax preferred accounts (401(k)s, IRAs, 529s, etc.) but only for very short-term trades. I can already hear the howls on this one as it might be characterized as the first step down the slippery slope toward elimination of tax advantaged vehicles. Still, if we want to provide an incentive for buy-and-hold, we can’t ignore tax advantaged accounts, can we? High-frequency trading can be done under those vehicles so why should they be exempt?

The point here is not to penalize everybody who wishes to participate in the market, but to make some (perhaps crude) distinction between types of market behavior. We already do this, as I said, so why not build on it?

What do readers who know finance better than I do think? (TFB, Mike, others?)

(*) This disclaimer serves as notice that this is a deviation from my M.O. You’ve been warned!

Note: I added the paragraph about tax advantaged accounts in a later update to this post.

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