Tax Bank Collapse Risk?

A week ago I said:

The main general approaches I know [to avoid total collapse] are refuges, to directly protect against the worst case, and the robustness rewards above, which counter-act known problems that distort our world economy toward fragility.

I suggested fixing current biases in intellectual property, empire bias, crisis metrics, and missing standards.  Here is a finance regulation proposal in the same spirit:

The Obama proposal for bank taxation has simple flat rates on uninsured bank liabilities. This is a better target than total liabilities since deposits were already insured, and the intervention bailed out wholesale funding.  But is such a flat tax designed to control risk creation? John Kay (2010) argues against it. Meanwhile Viral Acharya and Mathew Richardson (2010) argue that the bailouts have generated more moral hazard and suggest a fee discouraging all activity that creates systemic risk – not just leverage – and moreover that banks should be paying more in the good times when risk taking is more attractive.

In recent research, Javier Suarez and I (2009a, b) suggested a more subtle policy than President Obama’s – a Pigouvian tax based on banks’ individual contribution to systemic-risk creation, measured by their exposure to uninsured short-term funding. As in the Obama tax, this approach exempts insured deposits and targets the risk of sudden withdrawals of wholesale funding, which was the engine of the last crisis. Critically, our tax is sharper for shorter-term funding and decreases to zero for medium-term liabilities that do bear risk. In other words, it targets the externality caused by funding fragility and offers strong incentive effects in good times.

I’m not a banking or macro expert, and there is clearly a danger of fighting the last war here, but at least this seems focused on the right sort of problem.  HT Rob Wiblin.

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  • y81

    Perotti lost me (if he hadn’t already) when he referred to “near-demandable debt that does not correspond to retail depositor needs.” In fact, consumer demand for short-term assets appears insatiable, which is why money market funds are so popular.

    I seem to be the only person who remembers history. What spooked Paulsen et al. was not the failure of Lehman on Monday, it was the fact that by Friday (via the mediation of the Reserve Fund), it appeared that the commercial paper market was going to shut down, throwing every industrial company in America into insolvency. So my first question would be, is this heavy tax on short-term liabilities going to apply to everyone, or just financial institutions? Because if it’s just financial institutions, it only leads to further, and more dangerous, disintermediation. And if it includes non-financial companies, then (i) let’s drop the snarky references to the carry trade and (ii) let’s recognize that we are talking about something very different from the Obama proposal.

  • Eric Falkenstein

    Here’s a simple plan: eliminate the tax advantage of debt. Equity is taxed twice, at the corporate level as profit, at the individual level as capital gains/dividends. Debt is actually an expense at the corporate level, and so is taxed advantaged (though ultimately, interest income to the individual is taxed).

    This gives an incentive to increase debt. On obvious solution–that is politically impossible–is to set the corporate tax rate to zero, and then increase tax rates on individuals. Indeed, there are a lot of dead weight losses reduced there. But how about simply adding a tax based on debt? Interest expense could be taxed as if it were profit.

    When we add distortions and then ‘fix’ them via more distortions, we aren’t very good at anticipating the unintended consequences.

    • Robin Hanson

      Yes, sounds like a good and simpler suggestion.