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January 20, 2010

Why Dr. Tobin's Big Idea Should Remain Buried

There are few things sadder than the big idea born too early. We all know the story: A flash of brilliance is followed by years of public ridicule and frustration, the unrecognized genius eventually dying alone and penniless. Years later, the big idea is dusted off and re-examined, but this time, it's embraced, and we get the satisfaction of seeing the inventor's name belatedly join the pantheon of genius to which it rightfully belonged.

And so I had a warm feeling on behalf of the late Dr. James Tobin, when I read Paul Krugman's recent New York Times column announcing that the Tobin Tax was "an idea whose time has come." A "Tobin tax" is the en vogue name for a tax on financial transactions, named for Yale economist and Nobel laureate Tobin, who dreamed up the idea in 1971. After 31 years of advocacy, Dr. Tobin passed away in 2002 at the age of 84, having never experienced the pleasure of paying his own tax.

But now in 2010, eight years after being buried, it appears that Dr. Tobin's dream is being resurrected.  Not surprisingly, this required some help from the Lord--by which I mean Lord Adair Turner, of course, the chief of the FSA and the top financial regulator in Europe. Lord Turner strongly endorsed the tax last August, famously deriding traders as "socially useless," and saying the tax would be a "nice sensible revenue source for funding global public goods."

On Dec. 3, Dr. Tobin's idea took a big leap from the fringes, as Rep. Peter DeFazio, D-Ore., introduced the tax, subtly titled "The Let Wall Street Pay for the Restoration of Main Street Act of 2009." Unlike some of Mr. DeFazio's previous forays that were laughed out of Congress, this time he had lined up an impressive roster of 28 fellow legislators as co-sponsors. Sen. Tom Harkin, D-Iowa, introduced a similar bill into the Senate on Dec. 23, called the "Wall Street Fair Share Act," co-sponsored by three other U.S. senators.

So now Dr. Tobin's big idea has finally graduated from a dismissed intellectual theory into two very real-world proposals.  The two bills both tax stock trades at 0.25 percent (25 basis points in Wall Street parlance). In both bills, the tax is owed on any transaction that occurs on a "trading facility" located physically within the U.S., or anytime either the buyer or the seller is a U.S. person or entity. The tax is not based on the security being U.S.-based--an American who buys Toyota on the Tokyo would still owe 25 basis points to the U.S. government.

There are some differences between the two bills: Mr. DeFazio gives bonds a free pass, and gives futures and swaps a big break, taxing them at 0.02 percent (2 bps), while options are at the tax rate of the underlying security. Mr. Harkin's bill is harsher, taxing all securities including bonds at the rate of 0.25 percent, except for ones that expire or mature in less than one year, which get a rate of 0.02 percent.

So how would traders react?  Well, many politicians think traders wouldn't react at all.  As Speaker of the House Nancy Pelosi said, 0.25 percent is so small, the tax would have "minimal impact." 

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