The International Monetary Fund has floated two new tax proposals as a means to rein in what is now being viewed in some quarters as the disproportionately large size of the global financial system (particularly banks) and force banks and financial institutions to help finance the cost of a bailout when they land in a crisis. Both proposals will be put before a meeting of G-20 finance ministers in a couple of months' time. The first of the two proposed taxes is the Financial Stability Contribution (FSC). This is proposed to be levied initially at a flat rate and is to be paid by all financial institutions. At the second stage, the rate of this levy will likely depend on the liabilities taken on by the financial institutions. While most financial institutions were expecting such a levy, and while it will satisfy some of the public outcry, it doesn't necessarily make complete economic sense. Financial institutions may become more reluctant to lend to borrowers, hardly something that will add to GDP growth. And even if they do continue to lend the same amount as before, they are likely to pass on the additional tax burden as a cost to the borrower. So, governments may gain revenue but borrowers may bear a cost.
The second of the proposed taxes is the Financial Activities Tax (FAT). This is proposed to be levied on the profits and pay of all banks. This additional tax will reduce the size of profits in banks and curb the kind of pay packets that are continuing to cause public outrage in the West. Again, the economics of such a proposal can be questioned. Banks already pay taxes on profits. Will this additional tax be levied on all banks, or just a few large ones? If it's the latter, and it ought to be since only big banks are viewed as systemic risks, how easy will it be to define what a big bank is? On pay, we have consistently argued that it is only appropriate for shareholders to take a final call on remuneration. Government-imposed taxes will only lead to novel ways of structuring compensation packages without really changing the risk taken by employees. Also, remember that if any of these proposals is to be effective, it will have to be implemented by all major economies, at least the G-20. Again, why should those countries in the G-20 whose financial systems have survived the crisis intact (think India, Canada and Australia, for example) agree to such punitive taxes on their banks? The IMF, of course, has an interest in laying out bold proposals—that is one way to stay relevant. But the G-20 must think carefully before adopting any radical, and possibly counterproductive, proposals such as these.
