Why the financial transaction tax proposal is DOA

November 4, 2011, 5:06 PM UTC

By Cyrus Sanati, contributor

FORTUNE — What do Bill Gates, Hugo Chavez, the Archbishop of Canterbury and protesting nurses have in common? They have all voiced their support for a financial transaction tax, which would likely decimate the profits of many financial institutions on Wall Street if it were imposed.

The calls for a transaction tax have grown in recent weeks and are now a major topic of discussion at the G-20 meeting in Cannes, France this week. But despite widespread public support for the tax, it’s hard to see it becoming law in the United States anytime in the near future. Nevertheless, continental Europe seems committed to getting one put in place, which could eventually put pressure on the U.S. and the U.K. to follow suit, especially if there are more market mishaps linked to high frequency trading.

A financial transaction tax is not a novel idea. Actually, the U.S. had such a tax from 1914 to 1966, when the tax forced investors to pay a small fee every time they executed a trade. It was intended not only to raise revenue for the government, but also to deter excessive speculation. Congress has flirted with the idea of resurrecting the tax in some shape or form ever since it went away back in the 60s, but there has never been enough support for one.

The damage such a tax could bring to Wall Street profits is pretty clear. The tax would undoubtedly decrease trading volume, which would hurt the bottom lines of broker dealers. It would also deliver a whack to the exchanges, which depend on high trading volumes to deliver profits for their investors.

A financial transaction tax has been proposed twice in the last five years. Such a tax almost made it into the Dodd-Frank financial regulatory bill but there wasn’t enough bi-partisan support to get it through committee. But on Wednesday, two of the biggest advocates of a transaction tax, Representative Peter DeFazio (D-Oregon) and Senator Tom Harkin (D-Iowa) introduced legislation that would impose a tax on equities and bonds at 3 basis points per transaction. That is equal to $3 for every $10,000 traded.

Europe’s push

The push for a transaction tax has gained momentum in recent months thanks to support from French President Nicholas Sarkozy and German Chancellor Angela Merkel. The two European leaders are in favor of implementing a transaction tax across the 27-member European Union in a bid to wipe out excessive speculation, which they feel has become very destructive in many financial markets, most notably, the sovereign debt market.

In September, the European Commission proposed an EU-wide transaction tax that would levy a tax of 10 basis points on all transactions involving equities, bonds, and derivatives. The tax would take effect in 2014 and could raise as much as 54 billion euros a year, the commission said.

But for the tax to become law, it would need unanimous consent from all 27-members of the EU. As we have seen from the sovereign debt crisis, gaining consensus among European leaders is a gut wrenching affair. Indeed, such a vote would almost surely fail as the United Kingdom has said it is against any transaction tax that doesn’t involve U.S. participation.

It should come to no surprise that the UK is opposed to the tax given the blow it could have on the City of London, which is Europe’s financial hub. While the commission’s report noted that the tax would bring in additional revenue, it also said that it could reduce Europe’s GDP by 0.5% and 1.8% — much of that probably deriving from reduced market activities in the City of London. That’s a big hit given that Europe’s economy is projected to grow by less than 2% next year.

Aware of the UK’s objections, Wolfgang Schäuble, Germany’s finance said last week that if consensus cannot be reached with all 27 members of the EU, he would then try to get the tax implemented first by the 17 members that use the euro currency. He said he was confident that after all the euro members implemented the tax, then the rest of the EU, as well as the UK, would follow suit.

Wall Street’s pushback

Here in the U.S., the transaction tax bill introduced by Sen. Harkin and Rep. Defazio looks to be dead on arrival. Neither lawmaker sits on his respective tax-writing committee where revenue bills are introduced. It is therefore unlikely that the Republican chair of House Ways and Means would bring the House version of the bill up for discussion. The bill’s best hope is to get attached to a larger, unrelated bill, but it is unclear if any bill will get passed in Congress this session given that it is an election year.

But there is growing consensus from diverse corners of society for some sort of financial transaction tax. National Nurses United, the main nurses union, which has aligned itself with the “Occupy Wall Street” movement, marched with other groups on the U.S. Treasury yesterday in support of a financial transaction tax. Also yesterday, G-20 members heard a presentation from Microsoft (MSFT) founder Bill Gates on the benefits of such a tax in helping countries pay for healthcare expenses. And earlier this week, the head of the English Church, Dr. Rowan Williams, urged the British Prime Minister to drop his opposition for an EU transaction tax on moral grounds.

Sen. Harkin is pushing the tax as a way to not only rein in harmful speculation, but also as a way to solve part of the nation’s debt woes. He told Reuters Insider on Wednesday that he projects the tax could bring in around $200 billion over the next 10 years. The Congressional super committee, which has been tasked with making billions of dollars worth of cuts to federal budget by Thanksgiving, might be tempted to look at the transaction tax as a way of offsetting some of the pain.

But Wall Street is working hard to prevent a transaction tax bill from ever seeing the light of day. While they will probably succeed in the short run, there is a chance that Congress could be forced to act down the road if there is any major market mishaps linked to high frequency trading. The “flash crash” last year demonstrated how high frequency trading algorithms can go haywire, causing the markets to freeze up. A few more flash crash-like events and there will probably be increased pressure inside of Congress to implement a financial transaction tax. Until then, though, it looks like the continent will be going it alone on this one.