Global taxes on all banks
History is made
What have they put in the water supply at the IMF? First they see the light on capital controls, and now they’re putting out ground-breaking ideas on the international taxation of banks. I’ve been reading the supposedly confidential (but available on the BBC website – if you have problems with this URL, just search on BBC + title of report) interim report to last week’s IMF Spring Meeting with a growing sense of astonishment and delight. There are some potentially historic shifts in thinking going on. Apologies in advance for a long post, but I think it’s worth it for this issue. To keep some kind of ceiling on size, I’ll post tomorrow on what the report says about the Robin Hood Tax.
The report, titled ‘A Fair and Substantial Contribution by the Financial Sector’, was commissioned by the G20 ministers, who at their summit in Pittsburgh last year, asked it to ‘“…prepare a report for our next meeting [June 2010] with regard to the range of options countries have adopted or are considering as to how the financial sector could make a fair and substantial contribution toward paying for any burden associated with government interventions to repair the banking system.”
The mandate is important – the IMF effectively stretched it to include the indirect costs of the crisis in the rich countries – fiscal stimuli, quantitative easing and all the rest, as well as the direct costs of bank bailouts, but unfortunately, stopped short of extending it a bit further to include the indirect costs of the crisis on poor countries, in the shape of a large fiscal hole that will need to be filled. And it was never going to extend it all the way to the wider need for innovative financing to meet aid targets and the big money needed to deal with climate change.
As widely reported in the press last week, the paper proposes two kinds of tax: a ‘financial stability contribution’ (FSC) and a ‘financial activities tax’ (FAT – the IMF has even acquired a sense of humour). The FSC seems to be based on the US ‘Financial Crisis Responsibility’ fee, and the FAT on the British and French Governments’ bonus taxes.
On the FSC: “One reason the crisis was such a painful mess was that many governments did not have the tools to wind down failing institutions in a quick and orderly manner. All too often their only options, both hugely unpleasant, were to either (1) let a systemic institution fail and bear the chaotic fallout or (2) pump in enough public support to keep it alive, so confirming the prior suspicion that these institutions were indeed too big to fail. Governments lacked a way to ‘resolve’—a new word even for many economists—large failing institutions.
Resolution means equity holders would be wiped out, management replaced, and unsecured creditors take a loss—a ‘haircut’—on their claims. All this should be nasty enough for owners and managers to reduce any problems of ‘moral hazard’ (taking too much risk in the expectation that someone else will bear the costs if things turn out badly). But most countries still don’t have such a mechanism. Financial stability requires creating them.
So where does the idea of a contribution come in? Resolution requires upfront cash, to reduce uncertainty for creditors (and the creditors’ creditors…) by quickly giving some value to their claims. And the industry should pay for this: it is, or should be, a cost of doing business just like paying for deposit insurance, or maintaining their information systems. This is what we call a Financial Stability Contribution (FSC).”
On the FAT: “FAT is just a tax on the sum of the profits and remuneration paid by financial institutions. Profits plus all remuneration is value added. So a tax of this kind would be a kind of Value-Added Tax or VAT. And that could make sense because current VATs don’t work well for financial services, which are largely VAT-exempt.
This means that a FAT of this kind could make the tax treatment of the financial sector more like that other sectors and so help offset a tendency for the financial sector, purely for tax reasons, to be too large—or too fat.
Now suppose that the base included only remuneration above some high level, and only profits above a ‘normal’ rate of return. Then the base of the FAT may not be a bad proxy for taxes on ‘rents’—return in excess of competitive levels—earned in the sector. Some might find taxing that excess fair.
Or one might include only profits above some level well above normal. Taxing away some of these high returns in good times may help correct for any tendency to excessive risk-taking implied by financial institutions not attaching enough weight to outcomes in bad times (whether because of limited liability, or because they think themselves too big to fail).”
Why does this matter?
1. The most orthodox of international financial institutions has just set out the basis for an international taxation regime
2. That sets precedents for how public goods other than financial stability could be funded – like climate change and development
3. The FAT explicitly aims both to shrink the financial sector, which has grown so large that minor fluctuations imperil the much smaller real economy, and to change behaviour to reduce excessive risk-taking.
4. The FAT’s idea of a windfall tax on rents could easily be extended to other sectors – like the suddenly super-profitable oil and gas industry (see BP’s latest jump in profits)
5. All this is a wonderful counterweight to widespread pessimism on financing for development following the crisis. If the IMF thinks we can rustle up 2-4% of global GDP as a resolution fund, suddenly 0.7% for international development doesn’t look such a big deal.
One big question that the IMF paper ducks (but will hopefully answer in its final version in June) is what level of rate (and thus revenue) a FAT could raise. For the FSC, 2-4% of GDP corresponds to $1.2-2.4 trillion, so to fill up the resolution fund over a five year period, it would have to raise about $400bn. Coincidentally, that’s how much the Robin Hood Tax campaign reckons is needed for climate change and development. So when the resolution fund hits its target, there’s a ready-made use for further revenue…..
The danger is that in the negotiations that follow, the FAT will be sacrificed to get the FSC. That would be a shame, as it’s the more interesting of the two proposals. The final version of the IMF’s paper will go to the G20 summit in Canada in June. In the UK, income tax was introduced in response to a crisis – William Pitt the Younger put it in his budget of December 1798 to pay for weapons and equipment in preparation for the Napoleonic wars. Could international taxation be the biggest legacy of the 2008-10 global crisis?