Dear Mr. President and members of Congress:

In the months that follow Tuesday’s midterm elections, and into the New Year, you all face three very significant challenges. You must:

  • Find a solution to the Bush-tax-cuts controversy.
  • Rein in the huge-and-growing U.S. budget deficit.
  • And better police Wall Street, which got us into this mess in the first place.

You can solve all three of these problems with a single, simple proposition. And you can do so without having to ask U.S. taxpayers to dig into their wallets or savings.

Let me explain.

A Single Solution

On Dec.1, just one month after Tuesday’s midterm elections, the National Commission on Fiscal Responsibility and Reform will propose spending cuts and tax increases to reduce the nation’s dangerous budget deficit.

[ad#Google Adsense]As taxpayers, we hope that the majority of those recommendations will involve cutbacks in wasteful public spending, which has grown excessively in the last decade and is a dangerous cancer on the national economy.

That’s because the other option is for the government to increase taxes.

There’s an unfortunate reality here: Most of the tax increases that would help slash the dangerous deficit – including some of the Bush tax cuts (those relating to dividend taxes, for instance) – would also damage the fragile U.S. economic recovery.

But there is an exception.

There is one tax increase that would generate substantial revenue, help knock down the deficit, and even produce major improvements in the operation of the capital markets in both the United States and abroad.

It wouldn’t increase taxes to U.S. households or most U.S. businesses, meaning it also wouldn’t harm the U.S. recovery.

I’m talking about a “Tobin tax” on financial-market transactions.

Tobin Tax Basics

The Tobin tax, proposed by Nobel laureate James Tobin in 1974, would tax transactions, whether on the stock market, in foreign exchanges, in the derivatives market, or potentially in the ordinary transfers we always use to make an income and pay our bills.

We do not propose instituting a broad-based Tobin tax at a high rate such as 1%. A tax at that rate would be hugely damaging to economic life in general, as it would suck appreciable amounts of money out of every transaction we undertake (at that rate, we’d be talking about taking $3 out of a $300 grocery bill, for example). It would drive everybody back to using untraceable cash, a huge boost for the illegal “black economy” and a major loss in efficiency and security. On Wall Street, it would force the derivatives and other businesses offshore, or close them down entirely.

That’s certainly not our goal.

However, a Tobin tax at a low rate – perhaps 0.01% or 0.02% per transaction – is a different matter, entirely. Even if that tax were extended to all transactions in the economy, it would have only a small effect on day-to-day transactions.

For instance, someone with an after-tax income of $70,000, receiving pay-slips net of tax, would have total annual transactions – including credit card spending, withdrawals of cash and other expected transactions – of less than $100,000. With a Tobin tax, a person in that financial situation would incur an annual tax of no more than $10 to $20, which could be painlessly extracted by computer. It would also be possible to exempt “retail” banking and credit-card transactions from the tax.

A More-Tightly Controlled Wall Street

The Tobin tax would play out very differently for Wall Street, however. Most affected would be the “high-speed trading” business (also known as “high-frequency trading”), in which investment banks set up powerful computers in the same building as the stock exchange. This enables these institutions to get the “tape” of trades more quickly than their competitors, and then use this information via computerized “algorithms” to execute very fast trades, profiting from the result.

The margins on this business are very slim – perhaps as little as 1 cent to 2 cents per share on a $20-per-share trade. So even a 0.01% tax, costing 0.2 cents per share, would reduce those margins substantially. At the same time, this business is very profitable, making Wall Street more than $20 billion in 2009, with the leading firm, Goldman Sachs Group Inc. (NYSE: GS), reaping perhaps $5 billion of this profit. Thus, the Tobin tax at even 0.01% would tax 10% to 20% of this profit, producing $2 billion to $4 billion in revenue from this tax alone.

However, a Tobin tax would also have a similar effect on the massive derivatives market. The total current nominal value of derivatives contracts outstanding was $542 trillion as of December, the most recent figures available. Since most of these are short-term in nature, we can assume that annual trading volume totals at least this amount, with netting of contracts between the major houses probably increasing it further.

A 0.01% Tobin tax, which would have to be imposed in all the major financial centers to catch the full flow, would thus yield about $54 billion per annum in tax revenue, of which perhaps $15 billion to $20 billion would accrue to the U.S. government.

The most beneficial effect of a Tobin tax – beyond the revenue it raises – would be its effectiveness in cutting down on the so-called “rent-seeking” activities of Wall Street.

Both high-speed trading and derivatives operations are insider markets, in which the majority of profits are derived from knowledge of the trade flow of transactions in the market. That knowledge is not available to ordinary investors; indeed, in the case of high-speed trading, it is not even available to those with marginally slower or more-distant computer systems. High-speed trading and most derivatives operations are distortions of the free market, artificially enabled by modern computer technology.

While the derivatives market can provide a useful hedging function, only a small proportion of the $542 trillion of derivatives outstanding can possibly contribute to that function; there simply isn’t that much risk exposure to hedge.

As for high-speed trading, the liquidity it provides is of very poor quality. Indeed, systems such as this frequently produce “flash crashes” – like the one that hit the U.S. stock market back in May – as well as other pricing anomalies. And they are generally shut down in a one-way market, when liquidity is most critical.

Removing Wall Street’s “rent” profits from these sources is thus pure gain for the rest of the economy – and for the general public.

[ad#Google Adsense]If a Tobin tax cut down derivatives and high-speed trading activities by two-thirds, it would contribute maybe $10 billion in government revenue, or $20 billion if a 0.02% tax was imposed. And that isn’t the whole story. By cutting down these counterproductive activities, this new levy would release several times this amount in profits from Wall Street to the rest of the economy, generating jobs and productive economic activity at a time when the country needs it most.

We hate taxes. But the reality is that a “Tobin tax” – in addition to producing needed federal revenue – will level the playing field between Wall Street and the U.S. general public. And for the reasons we just mentioned, it will also pave the way for healthy economic growth – and productivity enhancements that will restore the United States to its rightful place as one of the most competitive economies in the world.

Given those projected bullish outcomes, this is a tax we can live with.

Action to Take: Support our campaign to institute a Tobin tax to repay the American people for trillions of dollars in bailouts and to curb the one-sided, “rent-seeking” trading that’s become a Wall Street hallmark, and that services no real useful economic benefit.

If you wish to do so, we urge you to contact your elected representative in Congress right away. Here’s what you need to do.

Step 1: To find out who your congressional representative is, and how to contact them, please click here (Website address is: https://writerep.house.gov/ ).

Step 2: You can either write them your own letter, or feel free to cut and paste the model e-mail note that we’ve displayed just below.

In either case, we suggest using the following subject line (by using a consistent subject line, Congress will understand that a true taxpayer campaign is underway).

Subject Line: Support a Tobin Tax on Wall Street

Step 3: Make sure to include a link to this “open letter”

Step 4: Lastly, drop us a note to let us know that you’ve joined us in taking steps to fix this country’s budgetary and economic problems. Write to us at mailbag@moneymappress.com.

Feel free to use this letter:

Dear [Decision Maker],

I am writing to urge you to support the introduction of a Tobin tax to curb excessive “high-speed” trading on Wall Street, to attack the ruinous federal deficit and to reimburse the American people for the bailouts of those financial institutions deemed “too big to fail” by the government.

I do not support additional taxes on an already beleaguered American public. Instead, I believe it is the responsibility of the big investment banks to pay us back for the financial mess they helped get our economy into. That is why I support the introduction of small Tobin tax on transactions in the stock and derivatives markets.

A Tobin tax of around 0.01% or 0.02% would barely impact taxpayers, but it would impact the big investment banks that got us into this mess. It would minimize the “high-speed trading” that creates market instability and “flash crashes.” This small tax could potentially generate $2 billion to $4 billion in revenue from the investment banks – instead of saddling the American people with a higher tax burden.

Most importantly, it would curb Wall Street’s “rent-seeking” profits – a net gain for the rest of the economy and for the general public.

As a member of your constituency, I urge you to support this tax to level the playing field between Wall Street and the public you are representing in Congress.

For more information on how the Tobin tax would help the American public, please read this recent commentary published by Money Morning: http://moneymorning.com/2010/10/28/deficit-debate-tobin-tax-cuts/

Sincerely,

{name}
{address}

Sincerely,

— Martin Hutchinson

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Source:  Money Morning