Suggested approach: widen the debate to publicise all the benefits of each tax, then push for internationally coordinated asset levies together with national taxes on bank profits and selected financial transactions.
Since the last post here on this hot topic, two major developments have moved the debate a long way forward. The IMF has proposed two new bank taxes: a Financial Stability Contribution and a Financial Activities Tax, and a popular movement aimed at funding development (the Robin Hood campaign) has pushed financial transaction taxes onto the international agenda.
At the end of this month in Toronto, G20 leaders are likely to discuss global levies and transaction taxes, despite opposition from host country Canada and others. Germany, France , the UK and USA are keen for a bank levy on assets. No consensus exists on profit and transaction taxes.
So what’s on the table?
(22 June update - UK has introduced an asset levy and said it will consider a profits tax).
The IMF’s Financial Stability Contribution (FSC) would pre-fund a resolution authority. It would be levied on balance sheet and maybe off-balance sheet assets, and perhaps adjusted to reflect those assets’ contribution to systemic risk. In Obama’s version, it would be used to repay TARP money. In the IMF’s version it would build up over 5-10 years to create a fund (eg GBP 60bn in the UK) for use in combination with a resolution authority to wind up failing banks without taxpayer funds. The resolution regime would put bank creditors on the hook after equity holders, while funds from the FSC would finance the wind down of third party contracts. Together, they should lessen moral hazard and reduce the chance of taxpayers funding a future bail-out. After the FSC fund is built up, the tax could be continued as a general taxation measure.
The IMF’s Financial Activities Tax (FAT) would tax bank profits and remuneration, acting as a kind of value added tax on financial activity. The IMF argues that it could also be a proxy for taxing rents in the sector in order to reduce its size, and would reduce moral hazard by lessening the individual incentive to make big bets. The IMF’s proposal at present covers banks only and not private investment funds (ie hedge funds).
An interesting variation on the FAT is to treat any financial remuneration above, say 10x average national earnings (ie GBP 200k in the UK), as part of the bank’s taxable profit. The idea proposed in a paper by Tax Research could become a tool for reducing inequality in all sectors, and would improve shareholders’ powers of stewardship by making them more aware of ultra-high remuneration, since they would have to pay tax on it.
A Financial Transactions Tax (FTT) would work like a turnover tax and could be implemented on all types of securities at different rates. Originally proposed by Keynes and then Tobin as taxes on equities or forex to curb speculative short-termism and volatility, there is today no consensus about which securities would best be taxed, at what rate and for what the proceeds should be used. Instead there is a plethora of partisan and theoretical arguments for and against, mostly from the development and banking lobbies. What is clear is that the tax is now on the agenda as never before.
To fill the gap in evidence, Neil McCulloch of the Institute of Development Studies at Sussex University will shortly publish a neutral paper, entitled “The Tobin Tax – A Review of the Evidence”, which reviews dozens of research papers, sifting the empirical date on transaction taxes collected so far. He made four interesting discoveries:
First, FTTs do little to curb volatility and actually increase it if set too high. Those wanting to throw grit in the wheels of speculators therefore need to use other tools.
Second, FTTs could be implemented nationally without everyone rushing to Bermuda (“migration”), since today's technology and central settlement make central collection easy. He concludes that international agreement on FTTs is therefore not necessary, despite the bank lobby's argument, as migrants would have to pay the tax wherever they are.
Third, FTTs could raise significant revenue, as much as GBP 7bn in the UK on forex alone. His mid-range assumptions were elasticity of 0.6, a 20% avoidance rate and that the taxes are set at 10% of transaction costs for each type of security (eg, if equity trading costs are 3%, the tax would be 30 basis points, or only half a basis point for securities with low transaction costs such as currencies). Globally, FTTs on all securities would raise far more than GBP 100bn annually. This makes them a material revenue raiser for deficit-burdened countries and development aid alike.
Lastly, the final incidence of FTTs is broadly progressive. According to two studies, FTTs would fall mostly on hedge fund investors, bank employees and pension savers (IPPR p19 and Sony Kapoor) but the evidence is mixed and the only safe conclusion is that they are likely to end up with owners of capital, making them more progressive than income tax and VAT.
The IMF decided not to sponsor FTTs on the ground that they don’t reduce systemic risk, which was its primary mandate and is better met with the FSC and FAT. However, they were sympathetic to the idea and expressly left the door open for others (such as France and Germany) to pursue it.
The Panic tax is a leftfield proposal also from Neil McCulloch of the IDS takes inspiration from mechanical engineering to suggest a variable FTT that bites only in times of panic, aiming to curb herd behaviour and sudden swings.
Opponents of bank taxes cite the failure of a high FTT in Sweden, which at 1-2% merely drove the market to London. Recent proposals use much lower percentages. Other arguments against include a reluctance to use up political capital agreeing international taxes, doubts about the capacity of the financial sector to generate so much tax without unexpected economic consequences (this has some merit, although there is little said about the opportunity economic cost of leaving things as they are); horror at the admin burden (although additional tax reporting on a transaction level would give regulators more data on market activity including bubble formation), and that capital rules and living wills are far better ways to address systemic risk than taxes.
Finally, comes the argument from Josef Ackermann that FSC+FAT+FTT+Basel3 = too much cost for banks to bear, so lending and economic growth will suffer. This also has some merit and suggests that taxes should be implemented incrementally and reviewed regularly.
Making sense of the proposals requires some understanding about of the purposes of each tax. Most contributors to the debate are interested in one or more of the following:
1. to repay past and future bail-out and recession costs (according to the IMF, the financial crisis cost the G20 countries a cumulative loss of output equal to 27% of GDP. In the UK, that is a staggering GBP 325bn)So far, my guess is that an FSC would deliver 1 ,2 and 5; a FAT would deliver on all five, and FTTs would deliver all apart from 2.
2. to reduce the likelihood of future crises
3. to tackle rent-capture and shrink the financial sector
4. to curb short-termism and speculation
5. to raise revenue, eg for deficit reduction or overseas aid
The problem for reformers now is that while everyone wants to recoup bail-out money (1), avoid further disasters (2) and raise more tax revenue (5), not everyone agrees that financial markets need fundamentally fixing to address rent-capture and short-termism (3 and 4).
These two late-comers to the reform debate are now on the agenda as explicit goals for certain reformers. Until now, concern about rent-capture surfaced during the UK’s general election as bonus rage and led to a one-off tax but was never taken seriously in the City, where the free market still reigns, just about. Concern about short-termism has been bubbling away for some time, from outcry over the Cadbury/ Kraft deal, to this hard hitting statement last September from Warren Buffet and a host of luminaries at the Aspen Institute, but has not yet been centre stage in financial reform.
Neither issue has been a priority for the G20, which is focussed on disaster prevention, or the UK (at least until Vince Cable landed at the Treasury). There was concern about them in Brussels, which drafted the Directive on Alternative Investment Fund Managers, but only since the IMF started referring indirectly to them in April are they hitting the G20 agenda.
Reformers have more tools to play with than just capital requirements and living wills, but must be realistic how many of these can be implemented. If one assumes that all are necessary for the sector to return to function, reformers must decide which they want to promote first.
Reluctance from Canada, India and others is understandable and means national implementation should take precedence, for example with FTTs, where central settlement addresses the threat of migration. FTTs could be implemented in the UK gradually at a low rate on selected securities, increased as their incidence and effect is understood.
Update 22 June: One in the bag, one on the way - UK chancellor George Osborne today announced a levy on bank balance sheets (excluding Tier 1, retail deposits govt bond backed repos and tax assets), which will coordinate with levies in France, Germany and the US. He is also working on a FAT, having endorsed the IMF's approach. "We are exploring the costs and benefits of a Financial Activities Tax, on profits and remuneration, and we will work with international partners to secure agreement," he said.