Opinion

Hugo Dixon

After the Robin Hood tax

By Hugo Dixon
March 26, 2012

Move over, Robin Hood tax. Make way for the FAT tax and the hot money levy.

The European Union’s plan to put an impost on financial transactions, popularly known as a Robin Hood tax, is dying. That’s a good thing. The idea was taken up by the Occupy movement as well as luminaries such as Bill Gates. But it never made economic sense. Taxing transactions wouldn’t have dealt with any of the causes of the financial crisis such as too much leverage and excessive reliance on hot money. It would just have driven business offshore.

Britain has always opposed the tax, meaning it had no chance of being adopted by the EU as a whole. Now the Netherlands has come out against it, so it can’t even be applied across the whole euro zone. With Germany’s finance minister saying that the “smallest thinkable unit” for the tax is the euro zone, it is only a matter of time before the Robin Hood tax is buried.

EU finance ministers will discuss alternative ways of taxing finance later this week in Copenhagen. The guiding principles should be to rein in excess risk-taking and remove distortions that bias one form of economic activity over another. With these ideas in mind, there are three specific things Europe, and for that matter the rest of the world, should do.

First, countries should impose a “hot money” tax on banks. Such a levy would apply to a bank’s wholesale borrowing. Ideally, short-term wholesale money should face an especially high levy: excessive reliance on such easy-come-easy-go funding was a big reason why banks from Royal Bank of Scotland to Lehman Brothers came a cropper. A hot money tax would encourage banks to raise longer-term money or attract relatively stable retail deposits. It would also mean that, if governments did have to bail out banks in future, the industry would at least have paid towards its own rescue.

So far 11 of the 27 EU countries – including Germany, Britain and France – have imposed such a levy, according to KPMG. The rest should follow suit. So should the United States, which has been toying with what the Obama administration calls a Financial Crisis Responsibility Fee. Although nothing will happen before the presidential election, a hot money tax could be one of the ways America eventually brings down its deficit.

Second, countries should remove the tax system’s bias in favour of debt. In most places, companies can deduct interest payments from profit before paying corporation tax. This encourages firms to leverage themselves up to the gills. The whole economy, not just the banking sector, is affected. But lenders are doubly exposed. Not only do they have an incentive to pile on the leverage themselves; they periodically get exposed to over-indebted customers, especially real estate developers and leveraged buyout houses.

Third, financial services should no longer be exempt from value-added tax. VAT is a consumption tax which is applied at each stage in the chain of production. Companies add VAT to what they sell other firms, but get a credit for what they purchase. This means only the final customer ultimately pays the tax. But in the EU and other jurisdictions, banks are not covered. They neither apply VAT to the services they provide customers nor get a credit on the VAT they pay on their purchases.

This anomaly causes several distortions. Final customers are undercharged for financial services, meaning they consume too much of them. Business customers, by contrast, are overcharged as there is no VAT they can reclaim on what they pay banks. Meanwhile, lenders have an incentive to perform activities in-house which would be more efficiently done by other companies – because they can’t recover the VAT they pay to outsourcers.

The VAT exemption probably also loses governments money. No proper calculations have been done. But a tentative estimate for the UK puts the lost revenue at 10 billion pounds a year, according to last year’s Mirrlees Review.

Given all these problems, it might seem mad that financial services are exempt from VAT. But there is a reason. Banks don’t charge fees for most of their services. Instead, they make the bulk of their income from the spread between the interest they charge for loans and what they pay depositors. Dividing up this spread among specific customers so that VAT can be applied to every bill would be quite tricky.

There are broadly speaking two solutions. One is to work through the technical complexities. The other is to introduce a financial activity tax, known as a FAT tax. This is applied to a bank’s earnings and the compensation it pays employees on the theory that the sum of these is just value added by another name.

The FAT tax has potential populist appeal, not just because of its name. After all, in the current environment, who would object to taxing banker pay and bank profit? One wrinkle, though, would need to be ironed out before FAT was an ideal tax. Some way would have to be found of giving business consumers a FAT tax credit.

There’s no disguising the fact that it would be complicated to revamp the way that banks are taxed. But given the havoc they caused in the crisis, the fact that the sector is under-taxed and the way in which the current system distorts economic activity, it is well worth the effort. The near-death of the Robin Hood tax provides a golden opportunity to do so.

Comments
5 comments so far | RSS Comments RSS

Most of the proposed bank taxes are actually complex, cascading taxes with investors and consumers paying the final result. The Robbing Hood tax is the most inane of them all, with the entire focus on taxing investors and calling it a bank tax. Investors are already over-taxed and discouraged from investing. Debt has been encouraged with lax lending standards, tax credits, breaks, bail-outs, low rates, absurd leverage…

Posted by rhone | Report as abusive
 

I believe this is another case of attempting social engineering in a banking envirnoment through the use of a pejorative tax. It’s an attempt to influence what’s viewed as poor behavior (excessive risk taking) by reducing the profit potential of that behavior. But it’s wrong-headed. How much risk taking is too much? Who decides that? Is that adjustable to conditions? The answer is some risk-averse bureaucrat would decide. Any statute or regulation put in place would not be flexible enough to adapt to changing market conditions. If it were, you would simply be shifting the risk management from the banks to the bureaucrats. The problem is a lack of accountability to consequence for those at banks making poor decisions. It doesn’t need the introduction of some criminal consequence to poor decisions. But there should be some personal consequence, either financial or to one’s career. The culture that insulates someone from that is what needs fixing. Not the practice that is the symptom of that.

Posted by wildbiker | Report as abusive
 

Actually, the source of the problem is Government backing of massive, non-consumer deposits, loans, and other financial instruments. If the Government restricted itself to “little people” deposit insurance and let the big banks fail otherwise, the system would have a chance. As it stands, banks risk almost nothing. Their shareholders have almost no ownership say-so over the banks’ behavior and suffer all losses while the management, which is the real problem, takes outlandish risks and keep their jobs after they have “fired” their shareholders through financial failure.

The tax should land squarely on the backs of management rather than shareholders, and should personally persist after any bailout. Bailouts should guarantee no bonuses, or compensation named otherwise, be paid from the surviving entity for at least a decade. The managers are to blame for the misbehavior but suffer very few of the consequences. The pressure to behave must be applied to the decision makers.

Posted by txgadfly | Report as abusive
 

The “hot money” tax is what has been termed “interest” for a couple of centuries. If the Fed is going to give away money to the banks, the tax/interest is lost and the appropriate long-term incentives eliminated.

It seems the idea of creating a fund to bailout banks has been similarly applied by the Federal Deposit Insurance Corporation for decades. It seems to work quite well for depositors.

There is also another idea that has been around for many years called reserve requirements. If banks and insurance companies want to gamble, they shouldn’t be doing it with FDIC-insured deposits. Seems the ex-CEO of Citigroup, John Reed, now believes that Glass-Steagall should be reinstituted.

Sorry, but this is one of the lamest financial articles written in a while.

Posted by ptiffany | Report as abusive
 

Less than three years from now, there will likely be a need for another infusion of cash from the ECB to Eurozone banks because so much of that money has been invested in the futures of nations suffering under the weight of economic malaise and/or disfunction.

Should that infusion be subject to a ‘hot money’ tax?

Posted by breezinthru | Report as abusive
 

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