Chris Giles Only one cheer for banking levies

Am I alone in feeling increasingly uncomfortable with the the global clamour for new taxes on banks and bankers?

Do I feel sorry for put-upon investment bankers with new tax demands? No. Am I comfortable with the greed culture in  Wall Street and the City of London? No. is Barack Obama justified in asking for taxpayers’ money back? Of course. That is why we can give one cheer to the bonus supertax ideas in the UK and France; the US bank levy and the International Monetary Fund process of seeking ways to ensure the financial sector pays for its sins.

But there are two issues that nag away at me. First, as I have previously written, seeking to tax banks for state insurance is something of a counsel of despair, implying global efforts to improve financial sector regulation will fail. And second, I am worried about the incidence question: who will pay bank taxes? It seems far from obvious will be the owners or employees of banks.

Let’s take the two issues in turn.

New taxes are well down the list of necessary regulatory actions

Taxing banks is surely a fourth-order policy when it comes to financial regulation and preventing another economic crisis. Before taxation is considered, the authorities around the world should ensure banks are less prone to failure, are not too important to fail and operate in more competitive markets.

Much tighter capital rules and binding constraints on leverage and risk-taking are vital to improve the safety of banks, providing greater buffers before banks need rescuing by taxpayers. Efforts are progressing on this front slowly, but the crucial issue of how much capital banks will be required has been avoided to date and there are rows between central banks and accountants over definitions of bad loans.

At the moment, banks and their creditors know that if a crisis struck they would be protected for fear of a double-dip depression. But at some point, the most important regulatory change must be to stop banks being too important to fail. This is a long way off. The most the Bank of England would say on the issue when it released its December Financial Stability Report was that while the authorities remained years away from being able to contemplate the failure of large institutions, at least all countries’ regulators have adopted abolishing “too important to fail” as an objective.

Taxation is wrong  way to deal with bankers getting unjustified bonuses. If employees are exploiting investment banks’ ability to generate excess profits in good times, the authorities should be investigating and attacking the source of those rents, not accepting them and seeking a slice. Rent-seeking behaviour is at the root of many problems in financial services: competition between banks to poach staff and their associated rent-rich activities; competition between countries to locate bankers in their jurisdiction; desire of the bright graduates to go into financial services rather than other career options; and the list goes on. It should be attacked, but there is very little action here on the international regulatory front.

It is only when there are big rents, insufficient capital and banks reveling in being too important to fail, that taxation has a role to mop up some of the mess. Banking taxes should be to cover the residual risk of bailouts in extremely serious systemic crises, when competition, banks’ capital buffers and efforts to make institutions irrelevant enough to fail have all collapsed.

That is true today, but it raises the following question

Who pays?

As any student of public economics knows, the formal incidence of a tax rarely equals the effective incidence. So the question of who pays any bank tax is pertinent.

First up. Banks don’t pay, only people pay taxes.

If banking was a perfectly competitive industry other than having a  subsidy for the implicit insurance offered by taxpayers, you would expect too many banking services to be offered at too low a price. Any tax would be paid by consumers of banking services.

Banking is not perfectly competitive. Politicians assume it is bankers or shareholders, but that is far from obvious. With international markets of mobile capital, it is unlikely banks can pass taxes onto shareholders or creditors. Employees are a little less mobile, but still threaten to decamp to Switzerland at the drop of a hat, so the degree to which employees pay is limited – London employees, for example do not seem to be paying the UK bonus tax. That leaves the customers, who in an uncompetitive market, will probably pick up the tab through higher prices for financial services.

So with the important regulation issues sidelined and it quite likely that customers of banks will pay the banking tax, there can be only one cheer from me for the efforts to tax banks.