Obama plans to announce on Thursday a $120 billion dollar tax over ten years on the twenty largest financial institutions, according to Bloomberg. This could be a sensible idea if implemented properly. Nevertheless, it does not make sense as a reason to recoup losses on Troubled Asset Relief Program (TARP) investments that taxpayers made money on. (Yet, my analysis for the New York Times did show that the risk-adjusted returns, alpha, on taxpayers' best investments were very negative.) This bank tax would be the best if it were progressively structured so that the biggest of the big banks paid the highest rates.
Any tax proposed on the twenty largest financial firms should be progressive. That is, the tax rate on liabilities should increase with the bank’s liabilities similar to the income tax system. The systemic risk is much higher from the firms that have in excess of $500 billion in liabilities than the firms that have less than $200 billion in liabilities. It is those systemically risky firms that place the greatest burden on taxpayers going forward. Progressive taxes on liabilities would be one way of encouraging these giant firms with over $1 trillion in liabilities to break apart into small pieces.
I have pushed for higher capital standards for big banks to serve as a disincentive to becoming too big to fail. Yet, many small banks hold more capital than the banks that are now bigger than Lehman Brothers was. A tax may be necessary if the capital standards are not strong enough. Otherwise, the big banks will have a too low cost of capital because of taxpayers’ implicit guarantee to bail them out when waters get choppy. If this tax goes through, the bankers and their shareholders who never picked up a cigarette at Goldman Sachs (GS), Morgan Stanley (MS), Wells Fargo (WFC), JP Morgan (JPM), Citigroup (C), and Bank of America (BAC) will get a taste of what it feels like to be a smoker. Higher taxes are going to make their life more difficult.
Disclosure: I only hold long positions in broad-based index funds. I do not own individual securities in the companies mentioned.
