Experts square off on proposed financial-transaction fees. By Anne Kates Smith, Executive Editor March 17, 2010 Supporters say proposals to tax stock and derivatives trading could raise $150 billion a year and curb speculative trading. Burton Malkiel, a Princeton University professor, author and longtime Wall Street guru, says the tax is a bad idea.KIPLINGER'S: You say proponents of a financial-transaction tax misunderstand the market. How so? MALKIEL: I think they see this as a tax that will fall only on speculators who serve no useful purpose. The misunderstanding is that speculators are creating all the volatility in the market, when in fact arbitrageurs are making the market more efficient. A further misunderstanding is that somehow the public is hurt by all of the trading, when the opposite is true. How are we helped? Advertisement First, the market is made more efficient. Second, it is made more liquid, and that means investors benefit from lower transaction costs. Explain, please. Here's an example: One of the most popular exchange-traded funds is SPDR S&P 500 (symbol SPY). It's an index fund that tracks Standard & Poor's 500-stock index and trades like a stock. But the ETF might trade at a slightly higher price than the 500 stocks themselves. To capitalize on the discrepancy, the arbitrageur sells the ETF short and buys the 500 underlying stocks. That brings the ETF in line with the value of the stocks and makes the market more efficient, ensuring that people will get a fair price. What did you mean about transaction costs? Advertisement Over time, as volume has exploded, bid-ask spreads -- the difference between the price traders will pay for a stock and the price they'll accept for selling one -- have shrunk. That's the real cost of trading, the bid-ask spread. Suppose spreads widen as the result of a tax on trading -- and there is no doubt in my mind that as trading diminishes, spreads will widen. Then you'll pay more to buy and receive less when you sell. But trading in mutual funds and in tax-deferred savings accounts is exempt. so is $100,000 in trades per year. If spreads widen, it will hurt all investors. As money comes into a mutual fund and the fund has to buy securities, it, too, will pay more in transaction costs. Investors often misunderstand the importance of transaction costs because they're not reflected in expense ratios. But paying more in trading costs means total returns are lowered.