No Limit: Unintended Consequences

, Malcolm A. Kline, Leave a comment

In the academic and political worlds in which our laws are incubated and passed, there is one statute scholars and politicos routinely ignore: the law of unintended consequences.

“In the wake of the recent financial crisis, several commentators have suggested a trans­action tax on financial markets,” George H. K. Wang and Jot Yau point out in a policy analysis for the libertarian Cato Institute. “The potential consequences of such a tax could be hazardous to the financial markets affected as well as to the economy.”

Wang is research professor of finance at the School of Management at George Mason University, and former deputy chief economist at the U.S. Commodity Futures Trading Commission.  Yau is Dr. Khalil Dibee Endowed Chair in Finance at the Albers School of Business and Economics, Seattle University.

“We find that the impact of a transaction tax on market activity (trading volume, bid-ask spread, and price volatility) will determine the potential of such a tax as a source of government revenue,” they write. “We also find that the current estimat­ed elasticity of trading volume with respect to a transaction tax in the U.S. futures markets is much higher than those reported in the extant literature and those used by the government in such computation.” Wang is the  former deputy chief economist at the U.S. Commodity Futures Trading Commission.

A review of the literature and estimates con­tained here indicates that there is an inverse relationship between transaction cost (bid-ask spread) and trading volume; to the extent that a transaction tax increases costs, trading vol­umes will likely fall. There is also a positive re­lationship between transaction cost and price volatility, suggesting that the imposition of a transaction tax could actually increase financial market fragility, increasing the likelihood of a financial crisis rather than reducing it. Perverse­ly, the imposition of a financial transaction tax could have results that are exactly the opposite of those hoped for by its proponents.”

Finally, there is no statute of limitations on the law of unintended consequences.


Malcolm A. Kline is the Executive Director of Accuracy in Academia.
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