"Congress can raise taxes because it can persuade a sizable fraction of the populace that somebody else will pay." -- Milton Friedman

The Congress has a new brilliant idea to make Wall Street pay for its sins. The proposed transfer tax of 0.25% for each financial transaction is being promoted as a matter of fairness. Wall Street needs to pay back all of that government largesse it has been receiving, and taxing financial transactions is perceived as the way to do it by some of our politicians in Washington.

The only problem is that Wall Street doesn't pay taxes, people do. The real burden of this tax, as with any tax, will fall upon individuals who are involved in the economic activity to which the tax is applied.

In the case of the transfer tax, that means anyone who buys and sells securities, either directly or indirectly, will become poorer since 0.25% of every trade would go the government. With investors already suffering from one of the worst bear markets in history, the last thing investors need is to lose even more money on each purchase and sale of securities. This tax will also discourage people from trading, and that will reduce liquidity in a market that has become increasingly volatile and illiquid.

The case can be made that a reduction in speculative trading would be good for the market, but this tax is not the best way to achieve that. It would be much better to do things like enforce stricter limits on hedge fund leverage and prime broker activity or to prevent these highly leveraged public ETFs called Ultra Funds from proliferating.

Hedge funds, their prime brokers, and these particular ETFs are the worst culprits in terms of excessive speculative trading. Individual traders and investors, who will be the hardest hit by the transfer tax, are not really the problem. Another way to limit speculative trading would be to properly regulate and limit the trading of credit default swaps and other speculative derivatives. Unfortunately, Congress is not sophisticated enough to understand how to approach this problem the right way.

The right way to tax Wall Street so it can pay back all of that money it has received from the government would be nationalize all of the firms and simply take 100% of their profits until all of the TARP money and other bailout money is repaid. That solution is very simple and effective, but it won't happen for political reasons and because Wall Street has far too much power to ever allow its firms to be nationalized and lose the profits that are being made.

Just look at all of the screaming about limits on executive pay at these firms that are basically on the public dole. Wall Street power brokers believe in socialized risk and privatized profits at the expense of the taxpayer and individual investor. It's too bad that our government, which is supposed to represent the interests of the taxpayers, can't figure out a fair and effective way to regulate Wall Street in the national interest.

The bottom line is that this transfer tax is just another shot in the dark by the gang who can't shoot straight in Congress. Every time they try to do something to help the economy or the market, you can be almost certain it will be made worse. If the government knew how to run the economy, we wouldn't need markets. On the other hand, when an industry relies on the taxpayer for support, the taxpayer needs to get that money repaid before that industry sees any profits and before the executives in that industry take home any significant compensation packages.

One really fair way of reducing the burden on taxpayers and getting some money back from the people on Wall Street who really benefited from the mess that they created would be to go back and force the disgorgement of executive compensation paid for the past five years in excess of $1 million.

If the government targeted the companies such as Citigroup ( C), Bank of America ( BAC), Wachovia, Goldman Sachs ( GS), Morgan Stanley ( MS), Merrill Lynch, Lehman Brothers, Bear Stearns and various hedge funds, that would return hundreds of billions of dollars to the Treasury that could be used to repay TARP and other facilities. Plus, it would come from the people who actually profited the most from creating a system that has destroyed our economy.

It also wouldn't do anything to punish current investors or restrict liquidity in the markets. So why not do it? Why not make the people responsible for this problem pay up? Why not stop taking blind shots at our economy and our markets that are just going to make things worse? Maybe because it would make too much sense and be too fair for Congress to ever approve it.
Christopher Grey is a managing partner of Third Wave Partners. He currently has no positions in the stocks mentioned in this article. This article should not be interpreted as personal investment advice or a recommendation to buy or sell any security. Interested readers may contact the writer by e-mailing cg@thirdwavepartners.net or visiting the company's Web site, www.thirdwavepartners.net.