Non-Value-Added Tax to Improve Market Fairness

Abstract

Promotion of both market fairness and efficiency has long been a goal of securities market regulators worldwide. While previous studies mostly focused on market efficiency, our paper proposes tools to improve market fairness. We define market fairness as the ability of a market structure and its regulatory framework to guarantee unimpeded competition while curbing excessive speculation and market manipulation. Such behaviors undermine the quality of financial markets in the sense that they cause volatility and lead to instability. To encourage value generation and improve market quality, we advance a graduated Non-Value-Added Tax. The proposed tax is implemented in a simulation-based model whereby a profitable transaction is taxed at the higher rate if it does not enhance efficiency measured by deviation from fundamentals. When an agent locks in profit not supported by fundamentals but driven by trend-following strategies, the generated profit is taxed at graduate rates under the Non-Value-Added Tax regime. Unlike existing Financial Transaction Taxes, the Non-Value-Added Tax is levied on profit and not on price. More concretely, our findings show that this tool encourages profitable trades that add-value to the market and discourages valueless profit making. It significantly curtails volatility, and prevents the occurrence of extreme market events like bubbles and crashes.

Keywords: {market fairness, market regulation, Non-Value-Added tax, high-frequency trading, bubbles and crashes, efficiency

JEL Classification: G14;D84;D85;E47;I31