Tax banks to make them smaller

By Felix Salmon
July 15, 2009

When the WSJ editorial page proposes any kind of new tax, it’s worth paying attention to:

Another answer would be an FDIC-style bailout tax, perhaps tied to leverage ratios, for those in the too-big-to-fail camp.

Janet Tavakoli is on a similar page:

U.S. taxpayers should insist that a large part of Goldman’s revenues and profits belong to the American public.

A Goldman-specific tax might be fun to attempt, but there really is a public good to be served in taxing what you want less of — which is too-big-to-fail banks making outsize bets with other people’s money (backstopped by the taxpayer, of course) and then paying themselves billions of dollars in bonuses.

The WSJ’s bailout tax idea is a good one — especially if it rose in line with a financial institution’s balance sheet, and gave those institutions a serious incentive to shrink. If you can’t legislate a hard cap on assets, then you can at least provide some gentle encouragement to get smaller rather than bigger.


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Would it have been out of the question to ask for an equal share of the compensation to go to taxpayers at the same rate as GS employees before the ‘loan’ was granted? oldman

Posted by Optimistic Dude | Report as abusive

This is also Buiter’s idea:

“(5) Tax bank size

When size creates externalities, do what you would do with any negative externality: tax it.

The other way to limit size is to tax size. This can be done through capital requirements that are progressive in the size of the business (as measured by value added, the size of the balance sheet or some other metric). Such measures for preventing the New Darwinism of the survival of the fattest and the politically best connected should be distinguished from regulatory interventions based on the narrow leverage ratio aimed at regulating risk (regardless of size, except for a de minimis lower limit).”

But note this as well:

“(2) Restore narrow banking or public utility banking

‘Public utility banking’ with just retail deposits on the liability side and with reserves, sovereign debt instruments and bank loans (secured and unsecured) on the asset side would take care of the retail payment, clearing and settlement system and deposit banking. Such narrow banking would represent an extreme version of Glass-Steagall approach. There would be deposit insurance and, should that fail, a lender of last resort and market maker of last resort. These tightly regulated institutions would not be able to engage in other banking and financial activities, and other financial institutions would not be able to take deposits withdrawable on demand or economically equivalent instruments.”

I think that Buiter has the best overall plan proposed so far. Read it here, or just take my word for it: o-big-to-fail-is-too-big/

Hey Felix,

Not posting on this story but unsure of how to reach you otherwise. I’m a Toronto guy and wanted to get your feedback on the Eric Sprott/David Franklin contention that we’re in a depression.

Any thoughts or counterargument? nce/July_2009.pdf



What would prevent the banks from passing the tax on to customers through higher interest on loans and lower interest on savings/checking accounts?

Accounting issue: the tax needs to be on the employee compensation, or on reducing the deductibility of the compensation. Otherwise, you have no effect on bonuses, since that (sadly enough), is a deductible expense and acts to lower the reported net income of the corporation.

Posted by Dollared | Report as abusive

drewbie, the theory behind the invisible hand of the market is that the giant banks who pass the tax on to their customers through higher fees will lose those customers to smaller banks who can charge less. if you believe in fairy tales like that.

On the part of the post about Goldman’s profits belonging to the government, the government subsidized Goldman’s profits, not just once by loaning them money, but also by giving them $12B or so when AIG no longer had collateral to back up the swaps they sold. I still can’t get over that gift, the government didn’t have to make AIG’s counterparties whole, they should have made them force AIG into bankruptcy. They wouldn’t have done that, because then they would have had to write down the value of the swaps, and they wouldn’t have wanted to do that.

Posted by KenG | Report as abusive

I’m currently reading William Cohan’s “House of Cards”, and I was surprised to learn that Bear Stearns often had their leverage ratio at 50-to-1 mid-quarter, then sold assets to bring it down to 35-to-1 for regulatory reporting purposes at the end of each quarter.

The WSJ leverage ratio tax would need to find a way to stop or at least impede such behavior.

Posted by Z. | Report as abusive

I’m not an accountant, but I don’t think you need to tax the bonuses. Compensation is paid out of revenue. If you tax the revenue on a sliding scale that factors in how “dangerously” (however you define that) the institution is operating, the money won’t be there to pay bonuses with.
Honestly, if a company that today pays a $1M bonus for a $100M deal (totally made-up numbers) still wants to pay the $1M bonus for a deal taxed down to $25M they can go right ahead.

Posted by Rockfish | Report as abusive

Rockfish, I agree with your point – although I made my comment because I think it’s impossible to tax leverage per se. You are creating a wholly new tax based on revenue, a very hard thing.

So, I think the more likely result is an income tax provision, but even then I’m doubtful; if you think regulatory arbitrage inspires creative maneuvering, you should see the creativity that goes into tax avoidance!

Posted by Dollared | Report as abusive

Understood. But I thought the point of our hypothetical tax was to keep the institution small, not so much the bonuses, (though the original post does mention both.)

I do agree that in short order the tax accountants would be the new Masters of the Universe!

Posted by Rockfish | Report as abusive