Professor Obama’s Bank Tax: What it is and what it isn’t

Recently, US President Barack Obama announced a new levy on the 50 top financial institutions in the US (some are US subsidiaries of foreign banks) whose aim is to repay to US taxpayers some of the costs they have incurred in dealing with the financial crisis.

Termed a “Financial Crisis Responsibility Fee”, it is in legal form a levy and can thus be implemented directly without congressional approval and be collected by the US Treasury, but de facto it is a tax.

The levy is to be imposed as a 15 point basis charge on all debt liabilities of financial institutions included in the scheme, other than their insured deposits. The US Treasury estimate is that 60 per cent of the revenue raised by the fee will be from the top 10 US financial institutions, and the revenue estimates from the levy run at $90 billion over an ill specified period of time.

At the political level, the levy is portrayed as a charge on the banks involved in the financial crisis. President Obama noted the “obscene” bank bonuses paid to bank executives recently as part justification for a policy move to recover some of the financial costs of dealing with the financial crisis.

At a more technical level, the argument is that US banks have benefitted from the de facto insurance that the US federal government provided to them by their actions at the October 2008 G8 Finance ministers meeting where (along with other G8 countries), in the midst of seeming financial meltdown, the US and other countries committed themselves to honour all the liabilities of financial institutions over which they had jurisdiction.

This new levy is a variety of 10 mingled instruments, none of which probably satisfactorily achieve their objectives, but which are quite understandable in terms of intent.

A recouping of insurance charge it is seemingly not, since insurance is something offered ex ante before the event and ex post payment for insurance is illogical even if one could realistically calculate the probabilities of events in this case prior to the crisis.

A tax on leverage being used both currently and in the future by the US financial institutions it would seem to be. Insured liabilities and their bank deposits used in conventional credit creation and intermediation by banks are all outside the scope of the tax.

As a tax designed to discourage future financial excess and aimed to potentially help head off future financial crises it seemingly has pluses.

A tax on windfall profits it seemingly is not in pure form. It does tax existing liabilities of financial institutions at date of entry into force, but it also applies to newly incurred liabilities of banks. A windfall profits tax would collect revenues in so-called lump sum form and not alter the behaviour of banks. This tax applies to newly acquired liabilities and so applies in ways which will affect banks behavior towards new debt.

Reportedly, the US Treasury Team considered four options before settling on this levy. These were a financial transactions tax, limits on the tax deductibility of interest payments by banks, a surcharge on bank profits, and the fee on liabilities they went with.

This new levy, in my view, has to be seen in the wider context of bank taxation generally which, globally, is chaotic and seemingly not based on clear principles. Banks in some countries are taxed on initial capital.

In most value added tax systems, financial institutions are typically exempt; they pay no taxes on their hard-to-measure outputs (intermediation services) while receiving no credits on their taxed inputs. Generally, around the world financial institutions and financial services in general are viewed as being lightly taxed relative to activities involving real side goods and services.

In this sense the Obama tax (and likely any of the other options) can be defended as helping level the tax playing field between financial and non-financial economic activity.

But at the same time there has been active academic debate over the issue whether it makes economic sense to tax intermediation providing services at the same rate as conventional goods and services.

In economic theorising in which real resources one used to provide loans to, say, buy a car and the satisfaction gained from buying a new car is the same whether priced in cash or through a loan, conventional arguments for a broadly based tax on both goods and financial services can break down.

Interestingly, there have been recent calls for a global financial transactions tax to form the basis of global public finances and to progressively replace the value added tax. With modern technology this is viewed as easy to administer, and with a large base the rate would be low.

The value added tax is now coming under question due to false credits, export refunds, and bogus credit issuing companies. The Russians are thinking of moving from their value added tax back to a sales tax.

The Obama tax, while for now small and likely immediately not to be matched abroad, could be a key initial intellectual step in this broader direction, independently of its financial crisis financing objectives.

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