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The Movement to Tax Banks

Much like how the health care debate coincided with a last-minute failure on Medicare buy-in, the financial reform debate coincided with a last-minute failure on taxing the banks. Both of the policies were compromises – Medicare buy-in was the climb-down from the public option (and single-payer), and the bank tax inserted in the conference report totaled $19 billion, a fraction of the $80 billion bank tax proposed by President Obama at the beginning of the year, and less than the resolution pre-fund tossed out in the Senate after howls from Republicans. In both cases, reformers and advocates haven’t given up on the idea. In the case of the bank tax, those reformers picked up a powerful champion.

The inevitability of future financial crises and the inability of regulatory overhaul to stop it mean banks should be taxed according to the bailout risk they present, a U.S. central bank official said Wednesday.

“A financial institution should be taxed for the amount of risk it creates that is borne by taxpayers,” Federal Reserve Bank of Minneapolis President Narayana Kocherlakota said. “Once the firm faces the correct tax, it will choose to produce that risk with a cost-minimizing mix of capital, liquidity, incentive compensation and other factors,” the official said.

Kocherlakota’s comments came from the text of a speech to be delivered before the Society for Economic Dynamics Annual Meeting in Montreal. The official doesn’t currently hold one of the rotating voting slots on the interest-rate-setting Federal Open Market Committee, and he did not comment on the economic and interest rate outlook in his prepared remarks.

Eventually, Kocherlakota will set on the FOMC, and his words should be heeded. He implicitly acknowledges that the reforms which will pass this month will not stop financial crises and will not end too big to fail, and he offers at least one prescription for dealing with that – at least have the banks who caused the problem pay for their cleanup. In fact, he notes that no regulatory policy, no matter how enlightened, can stave off such crises forever. If you cannot eliminate bailouts, you can at least ensure that the money comes from those both able to pay and responsible for the mess in the first place.

Other Fed governors, like the Philadephia Fed’s Charles Plosser, have expressed a desire to revisit the Wall Street reform to shield taxpayer resources from bailouts again. There’s actually a sliver of elite opinion amenable to this. Most policy fights are ongoing concerns, and financial reforms are no different. Engaging in that fight will protect a taxpayer base from committing their own money to save banks which caused the problem.

In Europe, they have also tried to manage risk through hitting bankers in their pocketbooks, in this case capping bank bonuses across the European Union. The rule would tie higher capital requirements to firms that don’t rein in executive bonuses. It ties the bonus allowances directly to performance as well. It passed 625-28, and will effect all global firms with business in Europe. This is actually part of a G20 initiative, so we could see it coming to the US as well.

Now, it’s just a hop, skip and a jump from a bank tax and a bonus crackdown to a financial transaction tax…

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David Dayen

David Dayen