International Cooperation and Taxing the Banks

23 Apr 2010

Shane Fitzgerald

At the 2009 G20 summit in Pittsburgh, leaders asked the IMF to prepare a report for their next summit (taking place in Toronto in June) on how the financial sector could make a fair and substantial contribution toward paying for the costs of future bank rescue packages. The report, leaked this week to Robert Peston of the BBC (and available for download here) proposes two forms of contribution from the financial sector, serving two distinct purposes:

A "Financial Stability Contribution" (FSC)

This levy would “pay for the fiscal cost of any future government support to the sector". It would be paid by all financial institutions, not just banks, initially at a flat rate but “refined over time to reflect institutions’ riskiness and contributions to systemic risk”. The revenue could either accumulate in a bail-out fund or be returned to general government revenues.

A "Financial Activities Tax" (FAT)

This covers any further contribution “that is desired” by governments. It would be levied on the sum of the profits and remuneration of financial institutions and paid into general revenues. This nicely-acronymed levy would hit hardest those companies which generate the highest profits and pay the largest bonuses.

The report notes that a number of countries have already begun to impose levies on financial institutions but argues that such unilateral actions risk being undermined by tax and regulatory arbitrage. Effective cooperation should not require full uniformity, but does demand broad agreement on principles, including the bases and minimum rates of new levies.

The IMF proposals have the virtue of relying only on a base level of cooperation, beyond which jurisdictions can choose to rise if they so wish. It is emphasised that any levy must be linked to an effective resolution regime to avoid the perception that the receipts would be used to prop up failing institutions.

At a time when banks are trying to rebuild their capital bases, these new costs will be firmly resisted. Those financial institutions not directly responsible for the crisis are particularly aggrieved and we can anticipate that many institutions will  try to pass on the costs to their customers.

Nor will these proposals get an easy ride from IMF member states. Many countries who survived the crisis relatively unscathed are resisting the idea. Canada is strongly opposed while Australian and Indian officials are also said to be cool on the idea.

Nonetheless, Dominique Strauss-Kahn, Managing Director of a resurgent and increasingly assertive IMF, argues forcefully for the need to reject ad hoc, national reforms. In proposing a tax on bank liabilities (the FSC) and profits and pay (the FAT) his organisation also explicitly rejects the notion of a so-called “Tobin Tax” on financial transactions, which has been proposed by the UK and Germany amongst others. This was the favoured approach of those who would “throw sand in the wheels” of global finance but has been dismissed as unworkable because unless every single financial jurisdiction signed up, the potential for international arbitrage would be too great.

As the EU prepares to discuss two key directives on financial supervision and fund regulation, and the Obama administration pushes for its own comprehensive financial reform bill, the IMF’s proposals are a timely reminder of the benefits of international cooperation. Despite its ambivalent reception, this report is likely to frame a large and imminent global debate on this issue.

Update: Carlo Cottarelli, Director of the IMF’s Fiscal Affairs Department, explains some of the thinking behind the proposals at the IMFDirect blog.

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