But there's one counter-argument that I don't like which is that such a tax would be bad because it would damage liquidity. Again proponents of a transaction tax need to acknowledge that reducing liquidity could indeed be a bad thing - it could easily make markets more volatile. But set at a low level that need not be the case. And equally opponents should admit that the benefits of liquidity can be over-sold, and that we can't assume that the existing situation is optimal.
Adair Turner gave this speech recently, and there's a section in it addressing precisely this issue titled 'A balanced approach to market liquidity'. Here's an excerpt.
scepticism about the limitless benefits of market liquidity and of the speculation required to make it possible, is justified on two grounds:The whole thing is worth a read.
First, the fact that the benefits of market liquidity must, as already discussed, be subject to declining marginal utility. The benefits deliverable by the extra liquidity which derives from flash and algorithmic trading, exploiting price divergences present for a fraction of a second, are clearly of minimal value compared with the provision of reasonable liquidity on a day-by-day basis.
And second, the fact that, to a degree which is difficult to predict and unstable over time, greater market liquidity and a greater role for speculators can produce destabilising and harmful herd and momentum effects.
Wot Keynes said.