$Stock*Shop*Charts*News*Option$

[Stock Lobster]

NP: Obama's 'revenge tax', Canada's Gain?

While other countries seek to punish their banks with punative taxes, Canada should invite them to move here

Jack Mintz: Obama's 'revenge tax'

Posted: February 11, 2010, 7:05 PM by NP Editor
By Jack M. Mintz

Last weekend, I passed up the Tea Party conference in Nashville for a New York University’s Law School conference on the financial crisis and taxation. While it might have been amusing to dress up in a 1776 costume and listen to Sarah Palin, it was far more stimulating to hear debate on the merits of new taxes imposed on banks, insurance companies and other financial institutions.

Two new taxes have already been created — U.S. President Barack Obama’s levy on risky bank liabilities and the bank bonus tax in Britain. Several G7 governments and international agencies are studying bank transaction taxes, potentially at the global level once recommended by the late James Tobin.

No question, governments are looking for a scapegoat in the wake of a rising tide of populist anger against those responsible for the 2008 financial crisis. Politicians, hoping to wipe their hands of blood, find it is far easier to pin responsibility on banks, the least-loved institution in society after oil companies. This is a much better strategy than acknowledging that lenders, borrowers, rating agencies, regulators, central bankers and governments themselves all played some role in creating the climate that led to a serious under-pricing of mortgage credit risk that spread throughout the world.

The new bank taxes are examples of what I call “revenge taxation,” imposed to exact a Shylock payment to cover economic losses. In fairness, revenge taxation does have one positive attribute if it helps curb moral hazard behaviour over time. In anticipation of future penalties, market players would be more careful to take on risky practices that lead to losses that taxpayers must cover through state-provided deposit insurance, pension guarantees and bailouts.

As presently constructed, however, the Obama tax will have only a limited impact in curbing moral hazard. The tax is designed to collect a payment to cover the cost of the TARP lending program that helped save several financial companies from collapse. It does have the virtue of being applied to non-insured liabilities, thereby imposing some cost on the most risky liability sources. This is quite different from past ill-designed Canadian capital taxes on financial institution shareholders’ equity and non-deposit debt that impair capital needed for financial strength.

The obvious problem is that the Obama tax applies to some financial institutions that did not receive TARP bailout funds at all, such as Canada’s TD bank. And, some banks such as J. P. Morgan, didn’t need subsidies in the first place but were forced to accept them. Even worse, some TARP recipients don’t pay the revenge tax at all, most notably the auto companies, GM and Chrysler. And then there are government-sponsored housing lenders, the biggest culprits of all — Fannie Mae and Freddie Mac — that escape the tax but have received billions in government support.

The revenge taxes will make it harder for financial institutions to raise equity, which will undermine their financial strength. Besides, the Obama tax will have a limited impact on those viewed as responsible for the financial crisis: management and shareholders. The economic consequence of the tax will little affect bank shareholder returns since owners can invest in other sectors of the U.S. economy or in foreign assets. Instead, the banks will likely shift forward the tax to their customers, who will face higher lending rates or lower deposits rates. This will hurt the competitive position of those financial institutions subject to the tax, since smaller banking institutions are exempt even though they received support through deposit insurance and bailout funds in some cases.

The U.K. tax on bank bonuses is intended to curb bad management, which is resented for large compensation packages in wake of large bank losses and government bailouts. Certainly, rewarding managers for poor performance offends shareholders, who should be pressuring companies to revisit their compensation plans. However, the U.K. bonus tax is a blunt instrument that does not discriminate between those companies that practice good behaviour and those that don’t. The tax is really just a vote-getting redistributive device by an untested Labour government that has stayed in power far too long.

Neither the U.S. bank nor U.K. bonus taxes are viewed as sufficient penalties to impose on banks. Several blood-seeking countries including Austria, France and the U.K. are pushing for a global tax on stock, bond, derivative and other financial transactions. These taxes, however, do more harm than good and should be shunned by Canada.

While some argue that financial transaction taxes reduce short-term selling and price volatility, studies have shown that large swings in prices can arise when investors dispose of assets after holding them for lengthy periods. Financial transaction taxes will result in higher borrower costs and less interest paid to depositors, doing little to reduce financial intermediate costs that should be minimized as much as possible.

Further taxes on bank loan and deposits would encourage institutions to shift operations to safe havens. Bank transaction taxes can destroy derivative markets since margins are too small to support any tax on the gains and customers will carry large wads of cash for transactions rather than pay the tax. A Swedish financial transaction tax in the 1980s and early 1990s raised relatively little revenue — the tax base disappeared because many transactions shifted to the cash economy or to other countries.

Yet, at times when governments respond to populist movements like Tea Parties, bad policy decisions like bank transaction taxes rear their head. It will be important for Canada, which has a sound financial system, to avoid shenanigans in other countries. We are better off laying out a welcome mat for new financial firms to locate here and make sure they are regulated properly.

Financial Post
Jack M. Mintz is the Palmer Chair in Public Policy, School of Public Policy, University of Calgary.



Read more: http://network.nationalpost.com/np/blogs/fpcomment/archive/2010/02/11/jack-mintz-obama-s-revenge-tax.aspx#ixzz0fLz2QmMx
The Financial Post is now on Facebook. Join our fan community today.