Financial Transaction Taxes and Fire Sales

We study the impact of a nancial transactions tax on a market where financial institutions trade with each other. There are two main results: First, if all banks can honor their short-term obligations, a financial transactions tax is entirely neutral. Second, in a model with correlated investment risk and short-term financing of banks, a financial transactions tax contributes to financial distress and undoes other policy measures that are used to stabilize financial markets. In the long run, however, this tax induced change of financial market outcomes gives banks an incentive to reduce their maturity mismatch.