In what may turn out to be the first significant punitive action against the largest American financial institutions (top 50), US President Barack Obama has proposed a new tax to be levied on the liabilities held by banks (except FDIC-assessed deposits). The tax is proposed to be levied at a rate of 0.15% with the twin aim of recouping some of the government-financed bailout packages and preventing excessive leverage by the largest financial institutions. Of course, there is no guarantee that the US Congress, particularly the Senate, will allow such a tax. Several legitimate questions can indeed be asked about this proposal, which while satisfying the needs of populist politics (bankers must be punished) may not at best achieve the financial and regulatory goals it is supposed to. For one, the proposed tax will impose a heavy cost on major banks?it is, for example, expected to cost JPMorgan Chase and Bank of America $1.5 billion each. While the biggest banks and financial institutions have made a comeback, it is far from clear if they are anywhere near the kind of profitability and strength that they had before the crisis. Imposing a tax on them now may set back the financial system?s recovery process. Also, a tax on liabilities may force banks to rein in lending, something the US economy can ill-afford as it limps back to recovery. Needless to say, the tax will ensure that banking stocks take a beating, not an ideal scenario for a period when confidence is a precious commodity.
The government, of course, hopes to collect around $90 billion over 10 years with this levy. But if banks lose profitability over that period, the government stands to lose some amount in general taxation. There is also the danger that banks and financial institutions will resort to methods to evade the levy, thereby defeating the government?s aim. It is also highly debatable whether a tax on liabilities is the best way to ensure less risk taking. Less distortionary methods like ensuring higher capital adequacy ratios, and creating transparency in the working of derivative financial instruments, would be superior alternatives. In fact, if the tax is seen as an alternative to these options, risk will not be mitigated. The problem, of course, is political?Obama is under pressure to do something about bankers who are still making ?obscene? bonuses. Here, too, things may be changing without the heavy hand of the government. A number of prominent investment banks, including Goldman Sachs are voluntarily moving to give a greater proportion of bonus in either stock options or cash over longer time horizons than just a year. That may satisfy some of the populist thirst.
