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Don't Like High-Speed Trading? Tax It

David Callahan

Here's one explanation for a yo-yoing stock market that leaves millions of 401(k) holders biting their nails on a regular basis: The cost for an investor to buy and then sell a stock has fallen by half in the past decade, to 3.5 cents, as the New York Times notes today

With costs this low, old fashioned speculation makes more sense than ever -- and so does new fangled high-frequency trading by powerful computers.

Increasingly, though, things are going wrong -- most recently with Knight Capital losing $440 million in less than an hour because of a glitch in new trading software. Scarier still was the day two years ago when the Down plunged 600 points in five minutes, only to recover those losses minutes later -- a flash crash that baffled many experts and regulators. 

To be sure, as the Times notes, cheaper trades carry upsides for investors. I like the idea that the managers of my mutual funds can jump out of sinking stocks more easily or get into rising ones, and I like the idea of paying lower trading costs. But I'm sure I speak for many 401(k) holders when I say that overall I'd prefer a calmer, more boring market than a Wall Street prone to flash crashes and huge automated sell-offs whenever central bankers in Europe wake up in a grouchy mood.

In any case, as Demos recently noted, the average 401(k) holder pays hefty fees and too much trading is one reason. Ironically, cheaper trading may lead to more trading -- and higher trading fees overall. (Kind of like how those cheap prices at Target make you spend more than you planned.)

Frequent and high-speed trading has also further perverted the true purpose of financial markets -- which is to mobilize capital for productive purpose, not generate profits in a casino-like frenzy.

A financial speculation tax (FST) is one way to slow things down. As we have written here before, a tiny tax on financial transactions could yield big money and help tame America's fiscal challenges. But such a tax would also serve the useful purpose of decreasing the amount of trading on Wall Street, dampening the speculative tendencies of large investors and leading to more predictable returns for investors. In particular, an FST could add just enough to the cost of stock trades to subvert the business model of high-frequency trading, and that would be a good thing.

One of these days, maybe next year, Washington will take on tax reform. A guiding principle of reform should be to move from taxing positive behavior, like work and wealth creation, to taxing bad things, like pollution, over-consumption, and -- a must for the list -- financial speculation.