Securities Transaction Taxes and Market Quality

Abstract

We study changes in market quality associated with 9 modifications to the New York State securities transaction tax (STT) between 1932 and 1981 and 3 changes to the federal STT between 1932 and 1966. We find that when there is an increase in the level of an STT, individual stock volatility increases, bid–ask spreads widen, price impacts are greater, and volume decreases. We examine the propensity of traders to switch trading locations to avoid the tax and find mixed evidence that they will change locations. Overall, our findings support the notion that the imposition of or increases in an STT harm market quality.