Risk Markets And Politics

Wednesday, February 06, 2008

Tax Futures, "In Real Life"

I am very pleased to announce the world's first explicit tax futures on Intrade. I thank John Delaney and everyone there for their help and enthusiasm in getting these off the ground.

The contracts will forecast the highest marginal single-filer federal tax rates for 2009, 2010 & 2011. I expect trade to be concentrated in the 2011 contracts, as Bush's 2001 tax cuts are scheduled to expire that year, reverting the rate in question from 35% to 39.6%, while the lower bracket rates each increase by 3%. While it is less likely, Congress may also alter the Bush tax cuts for tax years before 2011, but such changes would probably impact 2011 as well.

If reasonable liquidity can be sustained in these markets, I hope that contracts will be added to predict corporate taxes, and other factors that contribute to individual effective tax rates, like the Alternative Minimum Tax and the social security cap. Given the tremendous hedging utility of such markets, maintaining a liquid two-way market might be tricky, although there are some obvious ways for any market-makers to hedge what might become a position more short of taxes than usual.

Please read the last post on "Policy Event Derivatives" below for some background on the potential benefits of such markets. I should add that while I am confident in their long-term value of making better group decisions and sharing risk, I am sensitive to some foreseeable pathologies, and don't want to give the impression of being too cavalier at this point. There are potential problems and side-effects stemming from the use of such markets that will be addressed later.