The too-big-to-fail tax

By Felix Salmon
January 13, 2010
Barry Ritholtz knows what he'd like to see in terms of a new bank tax, and I like the way he's thinking:

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Barry Ritholtz knows what he’d like to see in terms of a new bank tax, and I like the way he’s thinking:

Exempt small regional banks with under $25 billion in deposits. Make the tax progressive so it become increasingly larger as deposits become greater. $25-$50 billion in deposits is one fee (Let’s say 0.1%, that’s $25 million on $25 billion in assets). Have it scale to the point where its punitive — 1% on a trillion dollars in deposits.

The goal here isn’t to raise money — its to force the TBTF banks to become smaller — to break up the Citigroups and the Bank of Americas. This tax will restore competition to the banking industry.

I think that total liabilities are a better number to use than total deposits: we want this tax to apply to Goldman Sachs as well as Wells Fargo.

Barry’s plan might not be far from what the Obama administration wants to do — although I doubt that the fee will approach a full 1% of liabilities, no matter how big a bank gets. Shahien Nasiripour has talked to “a senior administration official”, who says that the tax is designed to claw back from too-big-to-fail banks the windfall they’re getting from their TBTF status. (Dean Baker calculates that windfall as being $34 billion a year.)

The banking industry, when this tax is announced on Thursday, will certainly start making noises about how the extra costs are going to be passed on to customers. And I daresay they’re right: if you bank with a TBTF bank, you might well see your costs rise. So move your money to somewhere smaller!


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I think it is counterproductive to conflate two separate policy objectives in one tax. The first objective people are talking about is the punitive or retributive or redistributive one of clawing back windfall profits. Given the likely incidence of future inflation, changes in the market structure of interest rates, and other likely market changes, this windfall is likely to dissipate over time. Do we really want to impose an ongoing tax or fee of some sort to correct this problem? Once the windfall disappears, higher costs will indeed be passed on to consumers. Far better to execute this policy objective through some sort of windfall profits tax.

Second, policymakers are worried about too big to fail. This is where a graduated FDIC fee or tax makes a great deal of sense, since we want to continue to encourage banks to remain or get smaller.

Let’s keep it separate, and clear. This will lead to better policy and will defend the objectives better against opponents who will rightly attack a combined approach as wrong-headed.

Posted by EpicureanDeal | Report as abusive

TED, are we not right to imagine that some nontrivial portion of profits at large institutions financial are connected to the TBTF-ness of these companies? Why not conflate the two? Or am I misunderstanding which windfall profits are at issue?

Posted by Sandrew | Report as abusive

Sandrew — I can easily envisage a scenario in the near future wherein windfall profits have disappeared, and yet the banking system is still dominated by institutions which are too big or too interconnected to fail. In fact, in that case, I believe the system will be at greater risk than it is today since those very institutions will not have the risk cushion of government subsidized profits.

We should discourage TBTF, but this discouragement should be ongoing and independent of whether such institutions are earning windfall profits for any reason. Recapturing a portion of those windfall profits should be a separate consideration, handled separately. Tax policy is too cumbersome, blunt, and persistent an instrument to be structured in an unnecessarily clumsy fashion, that’s all.

Posted by EpicureanDeal | Report as abusive

Link the insurance to size, to their risky practices, to their excessive compensation schemes…..yes, in the end, these costs will attempt to be passed to customers in some fashion. That’s fine and within the banks rights. And as customers, we have the right to move our accounts to other banks. That will begin tilting the scale against the TBTF banks in favor of the community banks.

BTW, I moved my accounts from a TBTF bank to a locally owned community bank. Greatly satisfying.

Posted by scott1959 | Report as abusive

Rather than talk about small banks vs. big banks, how about smart banks vs dumb banks, or safe banks vs. risky banks? Is it better to have 10 $25 billion banks fail than one $250 billion bank? Shouldn’t we try to make all banks that are backed up by the government less likely to fail?

We can accomplish this better by requiring increasingly larger capital ratios as liabilities get larger, and charging a higher interest rate on borrowing from the Fed (instead of a quantity discount, there would be a quantity penalty) as that borrowing becomes a larger fraction of liabilities. Creating a narrowly focused tax will only drive the creation of a narrowly focused loophole. If the goal is to reduce this risk of failure and the subsequent bailout, then we should make it harder for all banks to fail.

If a progressive tax is what you are seeking, though, then by all means do it for all forms of income. Banks aren’t the only recipients of subsidies – all of the natural resource industries (coal, oil, timber, mining, etc.) rely on massive subsidies from the government. Even the entertainment industry, which was given a huge gift from Congress when it enacted legislation that extended the length of copyright protection, has benefited from government intervention. Why single out the banking industry?

Posted by OnTheTimes | Report as abusive

Note: I just started out the discussion looking at Deposits, but in addition to making TBTF part of the tax, you can also make “Too Risky” part of the tax progression.

The bigger and riskier a bank is, the more danger it presents to taxpayers, the greater the tax rate. Tax reductions are based on lower leverage, less derivative holdings, more capitalization, etc .

Posted by Ritholtz | Report as abusive

A one time tax on these TBTF banks is nice, but really not critical at all in the big picture of things. I hope the WH is only using it as political drama, and more importantly, as a bargaining chip to get those banks to call off their lobbyists against comprehensive financial reform, which is way more important in the long run than a ‘mere’ few billions.

Honestly, if the financial reform gets watered down as the Health Care reform did, we will all be in deep, deep trouble for years ahead – we as the whole world.

Posted by jian1312 | Report as abusive