Tax Analysts Blog

Bank Tax: It's About Time

Posted on Jan 14, 2010

In times of war governments impose excess profit taxes. Why? The government's extraordinary need during an emergency can make some segments of the population very wealthy. This is morally unacceptable because war requires huge personal and financial sacrifices from most citizens.

The financial crisis of 2007-09 required the government to respond as it would in a time or war. Huge amounts of public debt were issued. And policies that were put in place to save the country on the brink of disaster made some people very rich. Financial institutions benefited greatly from government guarantees of their debt. They also benefited from a monetary policy that created an upward-sloping yield curve that allows them to this day to automatically make money by borrowing short-term and lending long. At the same time the whole economy suffered declines in housing prices, cuts in government services, reduced wages, shrunken retirement saving, and--worst of all--a rise in joblessness.

The Obama-proposed tax that will be formally announed later today will by all reports be levied at a rate of 0.015 percent of total assets minus deposits and bank capital. In other words this is a tax on bank borrowing in long term bond markets and short term commercial paper and repo markets. The banks' overreliance on the latter was at the heart of the crisis. Unlike the UK's proposed tax on bank bonuses, and the much-discussed (but going nowhere) securities transactions tax, this tax on finance is well-designed. Nor is it onerous It will raise on average a paltry $9 billion annually over the next decade.

Moreover, just as it is economically efficient to tax pollution externalities that impose costs on society, it is fitting and proper to impose taxes on the financial pollution that affects all of us. Does this mean the financial sector should be downsized? Well, yes. Just as any polluting industry forces to take into accounts its costs to the general public should be downsized.

Although the political debate will put on lot of emphasis on "punishing" banks and "paying back" TARP funds, these are not the issues. That's all water under the bridge. On a going forward basis a tax on bank debt is sound economic policy--even if all the banks and bankers that caused the crisis had disappeared and new ones rose up to take their place.

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