Will Banks Pass on Any New Fee?

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If and when the Obama administration unveils its new tax on banks, will the banks just turn around and pass that extra cost onto consumers? Matthew Yglesias and Ryan Avent both make the case that if big banks raised the cost of banking with them, that would be a feature rather than a bug. We want the big banks to get smaller, and if they become more expensive, then that will help shrink their market share.

On the other hand, there’s a good chance that any fee won’t be passed on to consumers at all. If the levy is based on bank size at the end of 2009, and if it’s a one-off fee, then that makes it a sunk cost. The economics of banking remain exactly the same in 2010 as they were before: any given fee or loan will be just as profitable for them post-tax as it was pre-tax. They’re still going to be trying to maximize their profits, of course, but they’ll do that anyway.

Might the fee at least reduce the amount of cash that the banks have available for lending? Yes. But this is a large reason for levying the tax in the first place. America’s fiscal and monetary policy during the crisis involved recapitalizing the banks in the hope and explicit expectation that they would turn around and lend that money into the real economy. They didn’t do that, so it makes sense to take some of that money back — certainly that part of it which is basically just windfall due to Fed policies.

The fee won’t — and isn’t designed to — singlehandedly eliminate the problems of moral hazard and systemic risk in the US banking system. But it will raise much-needed revenues for the government, from precisely the sector which made windfall profits in 2009 even as the economy as a whole continued to struggle mightily. I like it — even though I haven’t yet seen any indication of exactly how it’s going to be structured.