Should we feel sorry for the International Monetary Fund? Quite often the answer is yes. The Fund gets passed an international hot potato to write a report about because countries cannot agree; it then writes an equivocal report; and then gets it in the neck when – surprise, surprise – countries do not like the findings.
On the international tax on banks two of these three features apply. The Fund was asked by the Group of 20 to investigate how to make banks contribute to the taxpayer support they enjoyed when there was no consensus at all last September; and countries such as Canada and Japan hate the Fund’s report. But in this instance, the Fund did not write an equivocal report. The leadership of the IMF are fully signed up to the principle of an international tax on banks and have been staunch advocates of taxing banks for some time.
As the report says:
“Expecting taxpayers to support the sector during bad times while allowing owners, managers, and/or creditors of financial institutions to enjoy the full gains of good times misallocates resources and undermines long-term growth. The unfairness is not only objectionable, but may also jeopardize the political ability to provide needed government support to the financial sector in the future.”
The big question is whether a new tax on banks (or two new taxes as the IMF is proposing) will ever happen.
This remains far from clear, although the odds have improved since October when talk about international bank taxes appeared to be empty gestures giving the impression of being tough on banks without any likelihood of implementation.
Reasons we might see some sort of permanent bank taxes
- Momentum. The proposals were going nowhere fast until Barack Obama proposed in January a “financial crisis responsibility fee” to claw back the taxpayer cost of the financial rescue. The proposal was to raise $90bn over 10 years from a 0.15 per cent levy on the liabilities of large financial institutions. The US also proposes a “systemic dissolution fund” with a maximum size of $150bn in future to facilitate the orderly bankruptcy of financial companies. These suggestions have breathed life into the international debate because previous US opposition prevented other countries acting for fear of losing financial services business.
- Public sentiment. The public backlash against bankers is enormous and politicians in almost all countries have found that it pays to take a tough line.
- No one is proposing a global tax anymore. Countries fiercely protect their sovereignty on tax issues and the original proposals suggested a global tax. The IMF has steered well clear of this in its report. It suggests merely that “international cooperation would be beneficial” and that “effective cooperation does not require full uniformity, but broad agreement on the principles, including the bases and minimum rates of the [tax]“.
- Financial services do not attract value added tax Most of the G20 impose VAT but it is almost impossible to include financial services in a normal VAT system because the purchases and sales of a bank are ill-defined because banks make money by charging different interest rates on assets and liabilities. The IMF’s proposal for a Financial Activities Tax mimics a VAT system by taxing remuneration and profits and can be said to be correcting an element of under taxation for financial services. Of course, this argument carries no weight in the US, which does not (yet) have a VAT system.
But there are formidable obstacles remaining
- Canada is implacably opposed. Normally this would not be a problem, but Canada will chair the June G20 summit and it is the convention of such meetings that the rest of the group does not bully the host nation. The pressure can start immediately after the 27 June meeting however, and the subject will come up at the summit in South Korea in November.
- A lack of unanimity. If Canada rejects new taxes on banks, it is not too much of a problem. But if many more countries refuse to agree to a coordinated tax on the sector, the possibilities for tax and regulatory arbitrage grow quickly. Japan is decidedly lukewarm and a G20 agreement would not bind Switzerland or Singapore into similar action. Permanent and large bank taxes which do not have the support of Japan, Canada, Switzerland and Singapore would probably be a non-starter, since significant activity could relocate.
- Conflict with the direction of banking regulation. The IMF desperately tries to suggest bank taxes would help to make banks safer in its report. But the fact is that taxing banks removes potential equity capital and will require banks to raise more equity to be as safe as they would be without the imposition of a new tax. This does not prevent a tax and regulatory package improving the safety of banks and benefiting taxpayers, but will make such a package harder rather than easier to achieve.
- Moral hazard. There is a big fear that if banks are taxed to build a fund to deal with a future crisis, this will promote the impression that banks should take greater risks because they have pre-funded their own rescue. The Fund report acknowledges the moral hazard problem in Appendix 3, and tries to paper over the difficulties by linking the tax suggestions with proposals to create an effective bankruptcy regime for banks. The trouble is, as Canada has pointed out repeatedly, the proposals on bankruptcy regimes and attacking “too important to fail” do not require a bank tax to be successful, so there is no link in logic, nor in fact.
- Incidence of the tax. As any economist will tell you, the organisation which writes the cheque to government is not necessarily the person paying the tax. A VAT type of tax is usually thought to be passed on to bank customers, and a levy, depending on its structure, is likely to be paid by customers and employees to a large extent. The owners of banks capital probably pay less ultimately, since their money is mobile.
- Distortion. Most taxes generate distortions and a banking tax (unless it was levied on a measure of excess profits) would distort the behaviour either of the bank or its customers. One particular objection of the VAT style of taxation is that business customers would not be able to offset the tax against their own VAT bills and might make them too hostile to using financial services. The size of these distortions would depend on the size and structure of the proposed tax, so this is not an absolute obstacle, but one that will create arguments in the months ahead.
