The IMF’s bank-tax proposals

Squeezing the piggy-banks

The fund’s proposals offer cash-strapped governments some lucrative and popular ideas

Apr 21st 2010 | From The Economist online

THE IMF, with the harsh retrenchment packages it imposed on indebted countries, used to be accused of clobbering ordinary people in order to protect big finance. Now the fund has taken on the job of squeezing the banks to defend society. Ahead of the meetings on April 22nd and 23rd of finance ministers and central banks from the Group of 20 countries, it has emerged that the IMF is proposing that they introduce two worldwide taxes on financial institutions.

Ideas for global finance taxes have been floated before and got nowhere—most notably the proposal for a “Tobin tax” on foreign-exchange transactions. But any banker tempted to dismiss the fund’s proposals asjust another bit of idealistic policy-wonkery should think again: governments, most of whom are desperate to plug big holes in the public finances, have now been given a template for raising levies that are lucrative, wildly popular and come with the imprimatur of capitalism’s policeman.

The first, and probably least controversial, part of the IMF’s planis a financial-stability contribution (FSC) tax, which would be charged on the bulk of banks’ liabilities, except those of their deposits which are covered by official insurance schemes (which are in effect already taxed) and the banks’ equity (which they are being urged to build up, to bolster their strength). Roughly speaking, the FSC is a tax on banks’ debts, and its purpose is to compensate the public purse for an implied subsidy that the banks enjoy when they borrow money: investors assume that many of them are “too big to fail” and thus the banking system will be bailed out by governments in a crisis, which means the banks can borrow abnormally cheaply compared with their risk levels, because of the free insurance policy that the tax payers provide.

This public subsidy is at the heart of many evils. It is why bankers’ fat bonuses, paid from profits boosted by cheap funding, areunfair. It gives banks a potentially dangerous incentive to maximise their leverage and size. And it is why badly run, opaque or risky firmscan still command market confidence. Thus it is not difficult to make a case that, for as long as the subsidy exists, taxing it back is both just and essential.

The IMF’s report to the G20 says it would be best to find some existing measure of liabilities and apply the FSC levy to that. This would make it harder for banks to game the new tax system, or at least easier to spot when they are doing so. It also proposes that the levy be spread across the finance industry as broadly as possible, to avoid arbitrage between different types of institution.

For the sake of speed, the fund suggests that the levy might at first have to be at a flat rate. But over time it wants to fine-tune the rate so that financial institutions pay according to their “riskiness and systemicness”. This will be a challenge and, to the extent that it is possible, it is arguably the job of global capital-adequacy rules, which are already being rejigged under the auspices of the Basle Committee on Banking Supervision. Unlike in the area of fiscal policy, all the big countries are already signed up to this.

There are a few other points in the fund’s plan that need clarification. It says the FSC levy should be viewed as a series of prepayments for future crises, which the IMF reckons would build up to a kitty of 2-4% of each country’s GDP. But a tax that accurately recaptured the implicit funding subsidy might be somewhat higher than this. So might the cost of another banking-system bail-out. And muddled objectives seemed to have led the IMF to make some quirky decisions. It wants to include insurance companies in the tax too. But their liabilities are largely reserves for future payouts to policyholders—they are not generally held to benefit from the“too-big-to-fail” taxpayer subsidy, and thus the logic for imposing the levy on them is weaker.

A FAT target

The IMF’s second proposed tax will be levied as a proportion of banks’ gross profits before paybills. Its populist title, the financial-activities tax (FAT), hints that it is intended to assuage popular anger against fat-cat bankers, since it will be a levy on the pot from which their plump bonuses and pay-cheques are drawn. One merit of such a proposal is that it is an alternative to imposing higher taxes on all earners (as is already happening in Britain), which unnecessarily punishes enterpreneurs who might create the industries of the future.

However, the FAT is bound to prompt some quibbles. If it is essentially a levy on banks’ excess profits, then it is arguably duplicating the job of the first tax, the FSC. If it is a way of getting back at banks for colluding against or confusing their customers, then perhaps competition policy and regulation would do the job better than simply skimming off some of the ill-gotten gains.  Indeed the same argument could be made of the rationale behind the FSC: if the problem is the unfair public subsidy that the banks get, why not try to eliminate it rather than tax it?

For these new taxes to work properly, they will need to be implemented uniformly in most of the world’s larger economies. The G20 has the right membership to reach such an agreement. But it is a loose and argumentative group of disparate countries with little experience in negotiating and implementing common policies. If the G20 fails to implement the new taxes worldwide, some of its member countries are likely to go ahead with their own versions—Britain’s Conservative Party says it will impose the FSC levy if it wins next month’s election—but with a different objective in mind, that of curbing their budget deficits. If so, this will increase the risk that financial institutions seek to arbitrage the differences between each country’s bank-tax rules, something which could have unexpected, and unhelpful, consequences.

http://www.economist.com/business-finance/displaystory.cfm?story_id=15948811

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