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Lesson #1 – Tax Banks

Wait….what?

Fresh from the FT:

Gordon Brown said on Wednesday the world’s leading economies were close to agreeing a global bank tax, amid hopes in Downing Street that a deal can be concluded at the G20 summit in Canada in June.

The prime minister said those with the “broadest shoulders” should pay more, and insisted that the tax would raise “a substantial amount of additional money”. He admitted: “It’s not as high as you would like it to be because of avoidance.”

I actually have no intention of answering the question posed in the title of this post, far too challenging for a blog post and likely too soon to really tell.

I do want to make a point though. As a response to the financial struggles of the past nearly 2 years, how are the most powerful nations in the world coming to this conclusion?

Logic –

1.Banks were profitable throughout the 90’s and early 2000’s
2. Some of this profit was derived from crazy financial instruments lacking transparency or regulation
3. Housing market started to fall
4. Banks balance sheets reveal mortgages are heavily wrapped up in these crazy financial products
5. Financial meltdown
6. Bailouts
7. They’re starting to recover…apply tax

1-6 is a bit of history of the last decade or so, 7 marks what the quotes from the FT indicate. We’ve had this same discussion before regarding the oil industry and the auto industry. During the good times rent seekers like governments and unions like to go after the “extra” profits of corporations (many of which are owned by average citizens through retirement investments). In the run up to the 2008 election and during the summer of record gasoline prices, it was all the rage to levy a windfall profit tax on oil companies. During the recession and a period of falling oil prices, the oil industry struggled a bit. Too bad the government didn’t take more money during the good times, right? That seems so obviously wrong that I shouldn’t have to say so. Take the profits now so we can bail them out later…is that really the answer? The auto industry seems to confirm this as well.

Let’s use the example of an individual again to make this a bit more clear. Let’s start with Person A. In the first 10 years of his life, Person A makes a lot of money, but never saves any. Instead, A buys things for his friends. In the second 10 years, Person A struggles with the economy and goes bankrupt. Now Person B. Person B also does well or himself, but saves money along the way in the first 10. When the economy goes sour, he relies on his savings and investments that he’s made.

The example is a bit crude, but it’s clear that when A acts with disregard to the second period, he’s worse off than had he planned for the uncertainty of the second period. Academically, I think this falls into the category of bounded rationality and probably some other temporal phenomenon, but the point is that people value their immediate situation more. On a collective scale, this might explain the rent seeking activities of governments, unions, and even shareholders during times of growth.

On the other hand, this does not explain the current reaction to the financial crisis. Populist angst against banks seems to lead people to support policies like this. Struggling governments seem to frame it as an easy solution. However, considering the recession and financial meltdown does it really make sense to tax the group that just broke down? Furthermore, does this do anything to remedy the root cause of the financial crisis? It seems to do the opposite. Taxes often have a tendency to discourage behavior that is transparently taxable. Read another way – could this be a recipe for more complex financial products that regulators (including the IRS) don’t understand?

Related posts:

1. More Analysis on the Euro Mini-Crisis
2. Wall Street Reform
3. Financing the American Dream
4. Politicking Our Economic Woes
5. Concern for Our Future