Sunday, December 06, 2009

Windfall taxes on bank bonuses: why they are right

Update: The FT now thinks that the Chancellor "is expected to reject a windfall tax on bank profits."

Banks are blowing a lot of hot air about, screaming "don't tax windfall bonuses!" The UK government could be spoiling for this fight: as the Guardian notes, UK Chancellor Alistair Darling:

"is drawing up plans to face down the country's top bankers by taking the "nuclear option" of a windfall tax on their bumper bonuses as part of measures aimed at the super-rich. The dramatic move, which was off the agenda just weeks ago, is under active discussion as the Treasury and No 10 try desperately to control the explosion of public anger over bankers' pay."

The bankers are moaning, and their sense of self-entitlement is, apparently so strong, that there are

"rumours of senior Goldman Sachs executives buying handguns to protect themselves from the baying mob – the alternative of prudent self-restraint perhaps not occurring to them."

The bankers' wheedling is unjustified for many reasons, including:
  • To a very large degree, the profits which lead to such large bonuses are "rents" stemming from banks' special privileges, not properly earned income. Otherwise, the forces of market competition would have driven super-profits down to more normal levels. A good response to unearned income, generally, is to tax it heavily.
  • Related to the first point, these super-profits flow to a large degree from the backing of the state, as lender of last resort. The s
  • Banks, as we have noted, are not normal market participants. They have unusual privileges, responsibilities and effects on societies, and they should be taxed in unusual ways.
  • The point of government rescues is to protect the financial system, not to make bankers rich - especially those who through skewed bonus incentives, and otherwise) got us into the mess in the first place.
  • As Martin Wolf put it, "Windfall” support should be matched by windfall taxes."
  • As we have explained, the purpose of state bailouts is to recapitalise the banks. But we need to tax them too, to begin to pay for the process of cleaning up the mess they created. The best way to do this is to tax the bankers, not the banks. A windfall tax on bonuses does just that - it still allows the banks to build their capital.
  • Banks should pay an insurance cost for their licence to engage in risky activities. The insurance comes from the state, so (leaving aside regulatory capital requirements) the cost should be paid in taxes.
  • Public finances are going to be devastated for years, even decades. The public is rightly baying for bankers' blood. We live in democratic societies, and the politicians must respond to what the public wants.
  • In response to the cry that "they will flee to other jurisdictions and everyone will lose out" - nonsense: first, the taxing windfall bonuses will drive the dangerous and "socially useless" parts of banking abroad - the more, the better; second, moving the frame of reference from the national to the global level, then the argument disappears entirely. Third, so much of this kind of talk is bluster. The only thing that is required is leadership, as we have explained. What The Guardian is suggesting may happen would be an example of that.
A memo to the U.S. and British governments in particular: don't listen to those twisted arguments about "competitiveness". Show some courage - and tax those self-satisfied (and possibly trigger-happy) smirks off their faces.


Blogger LCP said...

Excellent analysis. Keep up the good work!

5:20 am  
Blogger Physiocrat said...

The trouble with windfall taxes is that whilst they provide a partial remedy to an outrageous series of events, they are based on no principle.

I would rather see a proper criminal investigation and due legal process, as it is hard to believe no crime has been committed such as "Obtaining money by false pretences", fraud, breach of companies' acts, etc.

There must also surely have been breaches of contracts which could be invoked under more general clauses such as duties of care, due diligence, etc. Those responsible should be punished in a direct and particular way if this is at all possible, with everything being brought out in open court.

Taxation needs to be based on sound principles and no law should apply retrospectively. That must be a fundamental principle of jurisprudence.

3:14 am  
Anonymous Adrian Wrigley said...

I'm a bit puzzled by TJN's approach here. We are told that "To a very large degree, the profits which lead to such large bonuses are "rents" stemming from banks' special privileges, not properly earned income." and "super-profits flow to a large degree from the backing of the state, as lender of last resort".
So why advocate a "windfall" tax on "bonuses"?

Surely if the state confers a special privilege to these organisations, the organisation should pay a special fee for it? It should not be a one off "windfall tax". And it should not be linked to payouts to staff.

It's great that TJN now links the unearned economic rents as an appropriate basis for taxation, but please develop the argument further in support of collecting the full value of other unearned rents, and extend it in the obvious way to natural resource and land rents. Windfall bonus taxes are not a systematic solution to a systemic problem.

Unfortunately, as regards the source of banking profits, it is not exactly the "backing of the state as lender of last resort" which is the key. It is the state supervised "closed shop" cartel which bans non-bank money issuance, coupled with the guaranteed market for the state's money through compulsory taxation. The government demands tax on production which can only be created by authorised banks. Lack of deposit guarantees does not seriously impede bank profits, as shown in pre-FDIC US banking.

If TJN supports the current special banking privilege, it should support charging the banks the full value of this privilege. Whether this is correctly called a "tax" is semantics - a "licence fee" would be more descriptive. A more sensible alternative would be for the government to be the sole creator of government-backed money - as the highly stable and successful English tally-stick system.

Let's see a long-term solution to the chronic banking problems, not just a sticking plaster for the latest hiccough!

2:32 pm  
Blogger TJN said...

TJN wouldn't generally disagree with most of what Physiocrat or Wrigley have to say. In the United States, we see bankers being led away in handcuffs. In Britain, these people get away with having eggs thrown at their houses. Well, charging a "fee" of some kind is not unreasonable (and regulatory capital requirements could be viewed as a "fee" or at least a cost imposed; insurance fees are another. Politics is the art of the possible, and this is also a "windfall" (or unusual) time - notably rebuilding banks' capital to stop deeper collapse - though only up to a point. So there is a case for windfall taxes.

1:18 am  

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