Regulation could make bank FAT tax unnecessary

April 21, 2010

The global banking industry resembles an obese teenager. All the relatives agree that drastic weight loss is necessary, but each has a different diet plan. The International Monetary Fund’s splendidly named FAT tax would slim down the banking sector by targeting profits and pay.

The Financial Activities Tax comes in two varieties. The simple version is a straight tax on a bank’s gross profits — before deducting compensation. A low rate could raise significant sums: the IMF reckons a FAT tax of just 2 percent on UK banks would raise 1.4-2.8 billion pounds.

The simple FAT tax would resemble a value-added tax for financial transactions. Most countries do not levy VAT on banking because it is too hard to work out where the value is added to loans. This tax advantage may prompt financial sectors to bulk up unhealthily.

However, the simple FAT tax has drawbacks. Because it applies to the whole industry, banks would be able to pass on the additional cost to their customers. Also, in countries that do not have a general VAT, like the United States, this special banking tax would actually increase distortions.

The complex FAT tax aims directly at excess bank profit and pay. This would raise less money but would address the banking sector’s core problem: the implicit taxpayer guarantee that enables financial institutions to consistently earn super-profits in good times — and distribute a large chunk of the spoils to employees.

But this proposal is indeed complex, or perhaps arbitrary. It relies on an official calculation of the “normal” level of bank profits and the “normal” level of pay. That sounds close to impossible.

Besides, global bank regulators are already pushing through measures that should achieve the same outcome as the complex FAT tax. Higher capital requirements will depress returns and resolution schemes should allow failing banks to be shut down safely, helping to remove the “too big to fail” subsidy.

Such measures may not offer as much help to cash-strapped governments as a FAT tax. But regulation, not taxation, is the better way to cut these banking behemoths down to size.

Comments

“The global banking industry resembles an obese teenager. All the relatives agree that drastic weight loss is necessary, but each has a different diet plan…..But regulation, not taxation, is the better way to cut these banking behemoths down to size.”

To the author: as cited above, you began and ended your article with conjecture, although I enjoyed reading everything in between. Why not just stick with the facts and a logical analysis instead of wildly throwing in unsupported statements? I’d like to hear from a sincere capitalist why “size” really matters on Wall Street. That appears to be much more of a scapegoat quality shared by the primary “villains” than anything based on economics or business strategy. Most firms will reach a maturity phase where at some point the only choice they have is to split up or divest in order to continue to generate the returns their shareholders demand. If a firm can continue meet return expectations with a $500B market cap, why would any pro-capitalist government prevent them from doing so? If the idea of “size” isn’t based on total revenue but instead market share, be reminded that some of the biggest problems came from smaller institutions. Nearly 150 smaller banks have been shutdown by the FDIC, along with numerous boutique investment firms who all failed for the same basic reasons as the big guys – leverage, risk, and poor management. In general, healthy institutions survived, unhealthy ones died, and size was not a common denominator.

I do agree that more regulation is needed, but not primarily on the processes involved. The regulation needs to be more on the people involved with these highly complex and fragile instruments. Too many people were getting involved without thoroughly understanding all the factors involved, and instead of admitting that, they allowed themselves to be outmatched by smarter players who were only counting the money they’d make off the deal. Lawyers need a J.D. and to pass the bar exam before most firms would hire them to handle a complex legal case, and doctors need an M.D. and to pass their boards before a hospital would ever let them operate on a human being. Why is it that a spoiled kid with nothing but an undergraduate Ivy League degree (business major optional) and a BlackBerry full of contacts can show up on Wall Street and be trading billions of dollars of other people’s money almost immediately? I would say that’s the much bigger problem….

Posted by RichardC | Report as abusive
 

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