Tax incidence for fragile financial markets

Standard tax incidence analysis deals with households and firms that buy and sell consumption goods, as opposed to financial institutions that buy and sell financial products. This paper develops a framework that allows us to study tax incidence on financial markets, and applies it to a financial transactions tax. A main result is that the tax may contribute to financial distress. Moreover, if the government has to bail out the debtors of failed financial institutions, the tax-induced increase in bailout costs may be larger than the increase in tax revenue, so that the government's overall fiscal position becomes worse.