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Thursday, January 14, 2010

The Financial Crisis Responsibility Fee

Calculated Risk summarizes today's proposal from the Obama administration for a "Financial Crisis Responsibility Fee" to recover the cost of the bailout of the financial system:

Proposed "Financial Crisis Responsibility Fee," by Calculated Risk: From Treasury:

Fact Sheet: Financial Crisis Responsibility Fee: Today, the President announced his intention to propose a Financial Crisis Responsibility Fee that would require the largest and most highly levered Wall Street firms to pay back taxpayers for the extraordinary assistance provided so that the TARP program does not add to the deficit. The fee the President is proposing would:
  • Require the Financial Sector to Pay Back For the Extraordinary Benefits Received: ...
  • Responsibility Fee Would Remain in Place for 10 Years or Longer if Necessary to Fully Pay Back TARP:
  • Raise Up to $117 Billion to Repay Projected Cost of TARP:
  • President Obama is Fulfilling His Commitment to Provide a Plan for Taxpayer Repayment Three Years Earlier Than Required: ...
  • Apply to the Largest and Most Highly Levered Firms: The fee the President is proposing would be levied on the debts of financial firms with more than $50 billion in consolidated assets ... Over sixty percent of revenues will most likely be paid by the 10 largest financial institutions.
There is much more detail at the link. The proposed fee would be 15 bps of covered liabilities per year.
Free Exchange gives the motivation for the tax over and abovethe desire to recoup the money spent bailing the banks out:
The administration is clear in its desire that this function as an incentive for banks to get smaller and less leveraged:
The fee the President is proposing would be levied on the debts of financial firms with more than $50 billion in consolidated assets, providing a deterrent against excessive leverage for the largest financial firms. By levying a fee on the liabilities of the largest firms – excluding FDIC-assessed deposits and insurance policy reserves, as appropriate – the Financial Crisis Responsibility Fee will place its heaviest burden on the largest firms that have taken on the most debt. Over sixty percent of revenues will most likely be paid by the 10 largest financial institutions.
What's mystifying, then, is that the fee will only apply until TARP has been repaid.

But how much impact will the tax actually have, i.e. is it substantial enough to serve as a deterrent? Will the levy be large enough to change the behavior of investment banks? FT Alphaville does some calculations:

A quick, very rough back-of-the-envelope calculation, has Goldman Sachs, for instance, paying a very conservative (i.e. assuming all of its deposits are FDIC insured, which is unlikely) 2008 figure of:
($884.55bn – $62.64bn – $27.64bn) * 0.0015 = $1.19bn.
Or, less than a tenth of the $10.93bn the bank spent on compensation and benefits that year.

Kevin Drum summarizes:

Ouch! That's hitting 'em where they hurt.

And if the Lucas critique type effects are stronger than anticipated (i.e. firms taking actions to avoid the tax), the tax burden will be even smaller.

What else might have been done? Progressive Fix has a list:

In the discussion of taxing banks and bankers, a couple of possibilities have been floated, some of which can reap short-term political points, others of which have the potential to promote progressive policies:
Bonus tax – One of the easiest – and politically most satisfying – would be a tax on excess bonuses. The British exercised this option on London bankers this past year. Bonuses in the City above a certain amount were taxed at a 50 percent rate. Banks responded by threatening to move offshore and – when that threat rang hollow – doubled the bonus pool they paid out to bankers. The end result was that the bankers whose decisions led in part to the crisis were financially unharmed, the British government raised a relative pittance in taxes, shareholders in City banks took a hit (as the bonus pools were increased at their expense), and the underlying fault lines in the British banking system remain unaddressed.
Transaction tax – The worst of the options would be a tax on transactions. As discussed before, this would merely pour sand in our financial system, breaking it and slowing economic recovery.
Excess profits tax – A more appealing option would be a tax on excess profits. A defining aspect of the financial bubble of the last decade was the fact that financial profits were 40 percent of overall corporate profits – more than double the slice financials made up of profits in the 1980s. A tax on these excess profits would rein that in. But while this could be useful, as Simon Johnson points out, it would be fairly easy to game, and end up being ineffective.
Tax on assets – A tax on bank assets above a certain amount addresses not just political sentiment that banks have made it through the crisis unscathed, but also the fact that banks are too big to fail. Encouraging banks to “right-size” themselves would make our economy safer from the systemic risk imposed by banks like Citigroup or Bank of America – which are debilitated but whose failure would be economically catastrophic.
Excess leverage tax – Taxing the leverage that financial institutions use to increase returns would allow us to avoid situations like that faced a year and a half ago when Lehman Brothers – leveraged over 30:1 – collapsed over the course of a weekend. It would make banks “safer” but would leave them still too big. In the event a bank were to fail, it would still be a systemic threat to our economy. This would be a more targeted version than an assets tax, but it would be harder to implement — definitions of leverage differ – and if not properly defined would leave hedge funds, insurance companies and other “non-bank financial institutions” untouched, leading to a crisis like that perpetuated by Long-Term Capital Management in 1998 or AIG last fall.

I'm not sure I agree with the conclusions on the transactions tax, particularly when applied to actions such as those described by Robert Solow:

Take an extreme example. I have read that a firm such as Goldman Sachs has made very large profits from having devised ways to spot and carry out favorable transactions minutes or even seconds before the next most clever competitor can make a move. Deep pockets in a large market can make a lot of money out of tiny advantages. (Of course, if you have any such advantage the temptation is irresistible to borrow a lot of money to enlarge your bets and your profits. Leverage is good for you, until it isn’t. It is not so good for the system.) A lot of high-class intellectual effort naturally goes into trying to invent ways to find those tiny advantages a few seconds before anyone else.
Now ask yourself: can it make any serious difference to the real economy whether one of those profitable anomalies is discovered now or a half-minute from now? It can be enormously profitable to the financial services industry, but that may represent just a transfer of wealth from one person or group to another. It remains hard to believe that it all adds anything much to the efficiency with which the real economy generates and improves our standard of living.

But that aside, I would have preferred to recoup the bailout money and increase the safety of the system at the same time through a tax on assets (to get at the too big to fail problem) and a tax on leverage (to reduce the damage the big banks can cause if they do fail).

[More on the proposal: NY Times, Washington Post, Wall Street Journal, Bloomberg, Financial Times, Steve Benen, Ezra Klein, , Mathew Yglesias, Felix Salmon, Jon Chait, Dean Baker, Brookings.]

    Posted by on Thursday, January 14, 2010 at 11:34 AM in Economics, Financial System, Fiscal Policy, Regulation, Taxes | Permalink  TrackBack (0)  Comments (36)

          

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