Tuesday, January 26, 2010

UK Bank Tax

Since the 1970s, the UK government has been generally unwilling to subsides firms. The free market logic is that
  • Government subsidies encourage inefficient firms to remain inefficient.
  • Subsidies encourage firms to expand beyond the economically efficient output. (remember the CAP was a government subsidy to farmers which led to all those wine lakes and butter mountains e.t.c)
This logic explains why many UK industries had subsidies removed and were allowed to go under if necessary (e.g. British coal).

There is a certain economic logic to this. As an economist, I would only justify subsidies if the industry had positive externalities to society. E.g. Trains help to reduce congestion on roads and pollution. Therefore a larger subsidy to train travel would be justified on this grounds. But, generally there is a real danger subsidies could lead to inefficiency and are wasted resources.

So what about the Bank bailout? Is that not a subsidy? The answer is Yes - a contingent subsidy, but still a subsidy of over £140bn nonetheless.

Governments have made it very clear that they will not allow banks to fail. If banks overreach themselves they can rely on government (taxpayer) subsidy to however much they need.

There may well be good reasons as to why we don't allow banks to go bankrupt (the number of US bankruptcies in Great Depression of 1930s is sufficient reason)

But, the problem is we have created a system of moral hazard. The government is effectively encouraging banks to expand beyond the sensible level. It encourages banks to take unnecessary risk. As I have said before, heads banks wins, tail taxpayer loses).

A bank tax can therefore not only be justified but seen as necessary to provide a necessary counterbalance to undesirable bank expansion and bank risk.

If designed properly a bank tax can be used to:
  • Tax excessive risk taking
  • Encourage banks to take more responsible lending practises.
  • Build up a fund to provide for any future bank bailout.
Banks will say they are being unfairly discriminated against, they will complain it is populist politics. They will say they have definitely learnt the mistakes of the naughty naughties. But, does anyone believe the banks are not capable of making exactly the same mistakes they made in the last decade?

And the tax may just help to repay the national debt which has been made far worse by the scale of financial bailouts.

1 comment:

Beauty and Health Editor said...

A bank tax could also be useful for the high fees that banks charge their customers for going overdrawn when in financial difficulty.

I think it's a good idea.

Besides, why should banks get free bailout money when...

1) They charge interest for loans, inclusive of other charges to their customers.

2) The bailout money happens to come from people who pay UK tax.

3) If a small business owner was suffering, would they get free money from the government to stop them from going under, no, so why should banks who are already making hefty profits from their loyal customers receive free handouts?