Friday, January 15, 2010

The Bank Tax

. Friday, January 15, 2010

Here are some quick-fire thoughts about Obama's bank tax:

1. This is a essentially a tax on risk, because it targets leverage ratios. In terms of economic theory or even social justice this makes some sense. Think of it as a Pigouvian tax: moral hazard exists for firms with an implicit explicit government guarantee, so this tax could help bring private and social costs in line. In other words, it could help banks internalize the social costs of their actions. Especially, as Daniel Indiviglio says, if the proceeds from the tax were put into a "rainy day fund" to be used only if/when banking rescues need to happen again. That isn't going to happen, but I guess that doesn't make too big of a difference.

In practice, of course, it isn't going to work like that since banks will be able to pass some or all of the tax onto consumers. This view is supported by the fact that banks seem to have no problem at all with this tax. In fact that could be the best outcome. If banks are somehow forced to pay the tax themselves, it could actually create perverse incentives for banks to lever up even more to offset the loss of revenue from the tax. There is an argument [pdf] that this was the effect of capital adequacy requirements when combined with risk-weighting and the Recourse Rule, and that that created or exacerbated the financial crisis we're still digging out of.

2. The Obama administration could just target leverage ratios directly by mandating prudential standards. But that couldn't happen for several reasons. First, because it would put American banks at a competitive disadvantage in globalized markets (unless it happened under the auspices of the Basel Committee, which it might). Second, because it wouldn't raise any revenue for the Treasury, which could use it right now. Third, because it's a good political move to tax the banks even if it doesn't have the desired effects. The public is seeking its pound of flesh right now, and a "Bank Tax" could help stem some populist rage, even if the public are the ones who ended up paying it.

3. The government is making money off of the bank "bailout". I'll repeat that: the government is making money off of the bank "bailout". Quite a bit, as it turns out. It's losing money on the "Main Street" auto bailouts and AIG, but not the banks. Now, this doesn't count the loss in tax revenue (from decreased economic output) that the financial crisis caused, but it does stand for something.

UPDATE: Mankiw makes some similar points.


The Bank Tax




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