The UK emergency budget, which will impose a £2billion tax on banks, both domestic and foreign bank operations domiciled there, along with the upcoming G20 meetings, is pushing a contentious issue to the fore: how and how much to tax banks.
There are two motivations at work. First, with most advanced economies keen to narrow fiscal deficits that blew out as a result of the global financial crisis, the perps are a logical target. Second, taxes are a way to discourage certain types of behavior.
George Osborne, the UK chancellor, said that France and Germany had pledged to implement similar levies. The Financial Times summarized the new taxes:
Mr Osborne said the new UK levy would be calculated on the basis of its total liabilities less core capital and insured deposits. So-called repo funding, liquid funds guaranteed with government bonds, would also be exempt. In a move to encourage banks to lengthen funding terms, the levy will be charged at half the rate on financing longer than a year.
Treasury documents suggested that the levy would raise £1.2bn next year, with the levy pitched at 0.04 per cent of targeted liabilities, rising to 0.07 per cent the following year, generating more than £2bn in 2012.
Mr Osborne said he would separately pursue a globally co-ordinated tax on bank profits or remuneration, as recommended by the International Monetary Fund.
Yves here. The biggest risk of banking is simultaneously their raison d’etre. They take short term funding and make longer term loans. When they screw up (either due to making too many bad loans or by having liquidity problems by going too far with the classic “borrow short-lend long” formula), the state has to rescue big banks. Since we haven’t solved the big bank problem, and banks seem constitutionally incapable of reforming themselves, the next best idea appears to be to nudge them in the direction of operating with bigger safety buffers. One of them, per the formula above, is to reward banks for relying more on deposits (which even though they technically can be withdrawn at will, from a practical standpoint are pretty sticky) and, when they borrow, for relying on longer-term funding.
The problem is that the UK bank levy appears to be a bit of sleight of hand, and may do little to change behavior. Even though, per the Financial Times, Osborne contended, “the new levy ‘far outweighs’ any tax benefits extended to the corporate sector as a whole, analysts disagreed. From the Guardian:
Deutsche Bank analysts noted the significance of the corporation tax change. “Taking 2% off the 2012 tax rate for the five banks listed in the UK would increase profit by £1.16bn, that it is should almost offset all of the banks tax. Overall a good outcome for the banks.”
But even with that sop, international banks are threatening to shift assets into Japan or Switzerland (note: I wouldn’t bet on Japan as a safe haven if the US, UK, and EU manage to act in a coordinated manner). Political and budget commentators in the UK noted that the banks got off easy. Unions in particular were unhappy both about the level of the levy, less than half of what had been anticipated, and worse, the failure to impose effective taxes on bonuses. Bank shares rose even as industry executives howled.
Unfortunately, there is not assurance that even this modest move to tax an industry that just wrecked the global economy will get much traction. As the Wall Street Journal noted:
Bank levies will be on the agenda at the Toronto summit, according to G-20 officials, as its leaders seek to maintain a united front on tax and regulatory changes to avoid a repeat of the recent meltdown. Officials are expected to agree in principle, as they have in the past, that citizens shouldn’t pay for the sins of their countries’ banks.
But in the details, leaders are likely to agree to disagree, say people close to the matter. The countries that have footed the bill to bail out their financial sectors—including the U.K., U.S., Germany and France—are backing various levies on bank balance sheets. Countries such as Canada and Australia see such levies as punishment for their banks, which were left relatively unscathed by the credit crisis.
Yves here. Cynics might say that the reason Canada and Australia have done well so far is first, their overheated residential real estate markets haven’t crashed yet. Second, as commodities-driven economies, they have been the biggest beneficiaries of China’s pumping a trillion dollars of liquidity into its economy during the crisis. Third, as as countries that are not capital exporters (as in they do not have high domestic savings rates) their financial institutions were not investors in foreign assets, and hence did not load up on toxic US paper. But don’t expect those arguments to carry much weight with politicians in those countries.
And in any event, these holdouts may not make much difference if the G20 members are successful in agreeing to implement measures to prevent banks from moving to avoid taxed. Presumably, that would include shifting assets or exposures. But it will take a real show of unity, plus some tenacity, to make even a modest measure like this stick.