In today’s Times, Lib Dem deputy leader and shadow chancellor Vince Cable advocates a 10% tax on bank profits to fund a ‘safety net’ until finance houses can be broken up and are no longer too big to fail. Here’s an excerpt:
Some bankers might claim that they are doing God’s work. But the banks all owe their continued existence to the British and American taxpayer.
Some have been supported directly — RBS, Lloyds-HBOS, and the fully nationalised Northern Rock — but all benefit from the guarantee that they will not be allowed to fail. UK banks have received the equivalent of £1 trillion — £1,000 billion — in taxpayer cash or guarantees. No other industry enjoys such protection. It should pay for it until it can be restructured so that it no longer depends on taxpayer support. That is why I believe banks should pay an extra levy on their profits as a form of insurance premium. …
At present banks have every incentive to expand into high-risk activities knowing that if they are profitable they boost returns and bonus pots, but if they fail they enjoy a state guarantee. The largest banks are too big to fail — and thus are too big. … That is why banks must be broken up, going way beyond the welcome but limited tinkering envisaged by the European Commission. … But commitment to reform is slackening as a “business as usual” mood takes over. Action must be taken quickly and, if necessary, in the UK alone, as it is here, rather than the US, France or Germany, that systemic risk is concentrated.
One step, which could be taken quickly in the Pre-Budget Report, is the introduction of a levy on pre-tax bank profits to ensure that banks pay for the taxpayer guarantee. I have suggested a figure of about 10 per cent, which, under present conditions, would realise about £2 billion towards reducing public sector borrowing and the structural budget deficit for which the banking crisis is largely, if not exclusively, responsible. …
Sometimes the best ideas are the simple ones. A modest levy on bank profits has a specific purpose — to provide insurance as long as banks enjoy a taxpayer guarantee — and raises a useful sum to reduce government borrowing. It can, and should, be introduced quickly. …
The banking sector is too important to be allowed to drift back to business as usual, accompanied by threats and blood-curdling rhetoric that change nothing. The key issue remains how to create a robust structure for British banking. A levy to pay for continuing taxpayer guarantees should help to create that.
You can read Vince’s article in full here.
The Voice enjoyed the (at time of writing) top comment in response to the piece:
Daniel Price wrote:
I long for a hung parliament so this man can become chancellor of the exchequer… he seems to be the only person that both understands the economy and the electorate.Go Vince!
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2 Comments
But only sensible banks like HSBC are making money at the moment. Isn’t there a danger that we tax sensible banks to finance the government to prop up their less sensible rivals? Is it a good idea to ask well run firms to bail our their less well-run rivals?
I welcome Vince Cable’s repudiation of the Tobin tax but, instead, he has proposed a tax on bank profits to help provide a sort of insurance premium to pay for the losses banks impose on the taxpayer when they go bust. It would be better to have other reforms to ensure that a “no bail out” pledge can be made credible, but let’s assume that we are starting from here, what is wrong with Vince Cable’s proposal?
1. Insurance this is not. The tax is not in any way related to the risk that a particular bank poses. It therefore increases moral hazard in the system by institutionalising bail outs (the sector as a whole is paying for bail outs so it will get bail outs) whilst profitable banks will be charged more regardless of whether they are more risky.
2. Given that better lending decisions lead to higher profits it taxes those banks that make the most prudent decisions. Of course, other things can lead to higher profits too (such as good luck with risky assets) but a well-managed bank will be more profitable in the long term and therefore will be penalised more than a badly managed bank.
3. The levy will be on profits before tax but not on profits before interest. The tax is therefore yet another tax on equity. This is extraordinary because it is partly the tax treatment of equity relative to that of debt that causes financial companies to create complex instruments to increase gearing in the first place. But Vince Cable now proposes what is, in effect, a subsidy for gearing.
The problems that Cable identifies with the corporation tax system which lead (he believes – I don’t entirely agree) to banks paying too little tax could be fixed from first principles. The imposition of this proposed levy is, I am afraid, entirely misguided.
Are there alternatives – ignoring a move to a completely deregulated banking system with no bail outs? Yes, there are. One could have voluntary risk-based deposit insurance where the banks that had casinos attached would pay more. If they did not want to buy deposit insurance they could find other mechanisms to signal security but there would be no bail out for anybody if a bank went bust without deposit insurance. Paul Tucker’s suggestion of contingent loan capital that turned into equity capital when a bank is close to insolvency is also very sensible. Banks used to have a lot of that – it was called “preference share capital”, but then our tax system penalised it so heavily it became more or less extinct. This should be a warning to Vince Cable about the unforeseen consequences of misguided tax changes.