Europe Sets Taxing Questions

In March, the IMF reported to the G-20 finance ministers on policy options for raising money from the financial sector to pay for the costs of government intervention. Since then, many policy alternatives have been publicly discussed.

One of the first concrete policy results came this week, when the European Commission proposed on Wednesday what it calls a “preventive” bank levy to constitute a “resolution fund” that could collect up to €50 billion annually.

Such a fund would be intended to insure against disruption of the financial system in the case of further bank failures. Yet it is undecided within the EU even whether such a fund would be managed supranationally (as Germany prefers) or whether the monies collected would remain in the respective national treasuries (as France and Britain prefer).

Still, if the proposals are approved at the mid-June summit of EU leaders, then they could be presented at the end of that month at the G-20 summit in Toronto, with a view toward their universal adoption.

Paul Krugman noted last November that this idea had a venerable intellectual forebear in the proposal by economist James Tobin for a tax on currency speculation, the so-called Tobin Tax. Ideas now circulating are differently targeted but similar in their intention to do away with short-term speculation and its associated volatility and risk.

Krugman paid special attention to a different variant, which proposes to tax financial transactions rather than banks’ balance sheets as the EU would do. He notes that collection would be done fairly, because the “transactions [are] relatively easy to identify and tax,” since a majority of them are “settled […] at a single London-based institution.”

Objections and confutations

Some of the proposals now circulating are subject to the criticism that the taxes collected under any regime would remain in the respective national treasuries. This would make those funds available to the respective governments for general-purpose or other defined expenditures.

It is an open question whether governments would be able to resist this kind of temptation, or (in view of the Greek debt crisis) even trusted to maintain the accounting ledgers properly. Such a lapse would contravene the stated intent and weaken the proposed bulwark against financial collapse.

As Parul Walia, a research analyst at Roubini Global Economics (RGE), explained to ISN Security Watch, “the proceeds of the tax should go to a global fund,” all the more so since the plan “is only practical if it is implemented globally.” The global fund would provide the resources for managing “bank failures and insolvencies […] in an orderly and systematic way.”

Yet Canada, which hosts the G-20 summit in a month’s time, has been sending its cabinet ministers around the world to drum up opposition to such a bank tax. Such a tax would only lead in the end to higher bank fees for consumers, so the Canadian public does not understand why Canada, which did not have to bail out its banks, should participate in levying such a tax.

According to Walia, RGE has concluded that a “responsibility fee” is preferable. This would be levied on “the largest and the most interconnected institutions, according to their contribution to systemic risk.”

It would have two components, an insurance surcharge (similar to the FDIC system in the US) and a tax that “imitates the financial institution’s contribution to systemic risk.” The thinking is that “large and complex institutions” would engage in less risky activities in order to reduce that tax; as a result, the system as a whole would be safer.

“Responsibility fee” and other possibilities

The EU proposes to introduce its bank tax unilaterally if it is not adopted worldwide.

However, expert opinion suggests that such a move would be impractical. Walia notes that the only partial introduction of such a tax “would induce banks to shift base and play with regulatory arbitrage.” Moreover, such a tax “does not target the source of systemic risk, [and therefore] it is unlikely to lead to a change in behavior.”

Canada may well prefer its own version called embedded contingent capital. According to the simplest explanation of this complex scheme, banks would issue securities that would be like bonds when there were no problems but which would convert into shares if the bank had problems. Yet even this approach leaves a great deal undefined, such as how embedded capital is determined and when it becomes contingent.

The RGE analyst concludes that “a tax on bank balance sheet is preferable [to a tax on financial transactions] as it combats the source of the systemic risk.” The “responsibility fee would, by contrast, be levied on the largest and the most interconnected institutions “according to their contribution to systemic risk,” because this would “internalize the cost of probable defaults.”

A responsibility fee would provide the resources for managing “bank failures and insolvencies … in an orderly and systematic way,” but it would “only [be] practical if it is implemented globally.”


Originally published at ISN and reproduced here with the author’s permission. 

Opinions and comments on RGE EconoMonitors do not necessarily reflect the views of Roubini Global Economics, LLC, which encourages a free-ranging debate among its own analysts and our EconoMonitor community. RGE takes no responsibility for verifying the accuracy of any