Home / Opinion / Columns /  Should investors worry about a Tobin tax proposal in the US?

Uncertainty about federal economic policy is greater today than any time in the last 40 years. On one hand, we have senior policymakers calling for increasing already massive budget deficits, locking in the loosest imaginable monetary policy for the foreseeable future, and boosting taxes on businesses, Wall Street and the rich, if inflation rates spike higher. On the other hand, we have a president and senior economic officials who are solid members of an alliance among mainstream liberal academic economists and Wall Street executives who have dominated Democratic party economic thinking since the Carter administration.

In the absence of clear pronouncements by top officials, a recent paper co-authored by treasury secretary Janet Yellen’s husband, Nobel laureate economist George Akerlof, may be our best insight into the Biden administration’s intentions. While the paper represents no official policy, Yellen is thanked in its acknowledgements.

The paper is valuable because it centres on one issue of dispute between academic liberal economists and Wall Street executives: Tobin taxes. The idea goes back to a 1972 lecture by Nobel laureate economist James Tobin, who suggested that a tax on short-term financial transactions could make markets more stable and efficient. Many liberal economists find the idea appealing. Wall Street hates it.

So, while Akerlof might have written about Tobin taxes without thinking of any political reaction, and his wife might have helped only with technical comments, this might be a suggestion that Wall Street input will be excluded from policymaking and liberal economists will try to find common ground with progressives.

In arguing for a Tobin tax, the paper considers scheduled release of information about a security, like corporate earnings. It assumes dealers, market makers and trading firms will buy if the news is good and sell if it is bad. Despite the oversimplifications, the model correctly predicts that dealers and market makers position their inventories before scheduled announcements to best accommodate expected order flow. This is normally considered a good thing, as it smoothens the market impact of events. One of the complaints about the Dodd-Frank rules is that they discouraged holding long or short positions, leading to less efficient markets and widening bid/ask spreads. The paper then introduces some transparent rhetorical tricks to make inventory positioning seem bad. Market makers holding inventory are called “front runners." Front running is a crime where a broker or other agent transacts for itself before executing a client order. Akerlof stretches the definition to mean any pre-emptive action by a broker. This is no minor lapse, with the phrase used 100 times in the paper. So the entirely legal and ethical practice of inventory management is labelled with a phrase referring to a criminal act.

Most market makers manage inventory passively. If they wish to accumulate a positive inventory, for example, they get slightly more aggressive in filling sell orders, and slightly less aggressive in filling buy orders. In the Akerlof model, market makers build inventory by seeking out “unsophisticated" investors. It seems to imagine that retail investors are ignorant of the scheduled information release and can be enticed to part with securities by bids fractionally above the last transaction price. Anyway, whoever they are, we’re supposed to want them to make more money. When ‘front runners’ reduce their transaction costs by spreading out their orders, ‘unsophisticated’ investors make less money. Finally, the paper points out that a tax on short-term transactions would discourage inventory positioning and deliver larger profits to ‘unsophisticated’ investors. Aside from other objections, taxing all financial transactions for the tiny fraction that represent market maker inventory positioning trades with unsophisticated retail investors is wildly out of proportion.

I cannot think of any scheduled information releases of the type the paper takes into account. Earnings and other big news are usually scheduled when the market is closed, or are done during trading halts. Government statistics released during the trading day affect thousands of securities, and no market maker is adjusting inventory positions in thousands of securities a few minutes before release.

But it’s the absurdity of the paper’s policy arguments that lead me to suspect it is a signal. Economists who read the paper will dismiss it. Non-economists who read second-hand accounts will seize upon a paper by a Nobel laureate that supports financial transaction taxes. Liberal economists can shut up, and let the progressives get a win on an issue that many of them think isn’t a bad idea—certainly not as crazy as, say, modern monetary theory.

Aaron Brown is a former managing director and head of financial market research at AQR Capital Management and author of ‘The Poker Face of Wall Street’.


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