G20-IMF-FSB Update – April 9, 2010
By Adam S. Hersh
Global Bank Levy
The G-20 had charged the IMF with exploring options for a global bank levy to help defray current and future fiscal costs of financial stability. The IMF is due to deliver an interim report at the April 22-23, 2010 G-20 meeting in Washington, DC, and will deliver a final report at the June 26-27, 2010 G-20 meeting in Toronto. Options under consideration by the Fund include a tax on bank balance sheets and excessive leverage, a tax on bank cash flows (which will be popularly branded as an "excessive profits tax"), a bank insurance levy, contingent capital instruments, and a financial transaction tax (FTT, a.k.a Tobin tax, such as that advocated by the Robin Hood Tax campaign). Proposals for a global bank levy are intended to make financial institutions bear the cost of ensuring their own financial stability (so that governments might avoid future public ire over the cost of bank bailouts and the egregiously anti-social behavior of bank executives). The UK came out early in support of a global FTT–extolled publicly by Prime Minister Gordon Brown, Finance Minister Alistair Darling, and Bank of England Governor Mervyn King–proceeds from which are to be distributed to national governments. The EU’s Commissioner for Development and Humanitarian Aid also proposed a Tobin Tax, and the idea has seen support in Germany, France, Australia, and Japan, too. The European Parliament voted 536-80 to support implementation of a FTT. France and Belgium have adopted legislation on a currency transaction tax, but this will only become effective if implemented EU-wide. In a letter to the G20 leaders, 350 economists called for urgent adoption of a FTT. Estimates of a FTT for the US, depending on the instruments to which the tax is applied and its impact on trading volumes, indicate that a 0.5 percent FTT would generate $177-354b annually.Other estimates of a FTT find that a tax of between 0.1 and 0.01 percent would generate revenues ranging from 0.5 to 2.4 percent of World GDP (depending on the tax rate and assumed impact on transaction volumes). The most revenues would be generated in North America, ranging from 0.7 to 3.6 percent of GDP, followed by 0.6 to 3.3 percent of GDP in Europe and 0.5 to 2.7 percent of GDP in Asia and the Pacific. Leaks from the IMF ahead of the Washington meeting indicate the Fund has all but ruled out a transaction tax.IMF Managing Director Dominique Strauss-Kahn declared the Tobin tax idea "all but dead" for being too difficult to implement and easy to evade. The evasion argument is often levied against FTTs–that the tax will merely divert trading activities to other, less regulated jurisdictions. But so long as countries spanning the major financial centers participate in implementing the tax, there is little risk. Efficient market operations are built on a foundation of strong rule of law, particularly in contract enforcement. This is why the leading financial centers are located in New York, London, Frankfurt, Tokyo, Hong Kong, and so on, rather than Kabul or Mogadishu. Instead of an FTT, the IMF is signaling it favors a cash flow-based tax on bank profits. From the IMF’s perspective, a cash flow tax is preferable because it is "efficient" and "non-distortionary," which is to say that it theoretically would not alter the incentives facing banks and therefore would not alter banks’ behavior. The downside of an efficient, non-distortionary cash flow-based tax is, of course, is that it offers no different incentives for banks to change their behavior. If banks were doing a good job of allocating investment resources toward productive real economy projects rather than towards financial trading activities, and were doing a good job of reallocating risk to those most willing and able to bear it rather than creating moral hazard for tax payers, then it would be clear why a "non-distortionary" bank tax policy would be desirable. But the global economic crisis shows this is not what large banks have been doing–by all means, let’s change bank behavior! Another downside is that it may be easy for banks to dodge a cash flow tax, as suggested by Peter Spencer of consultancy Ernst & Young.. So it is unclear why the IMF would prefer a policy leery of altering bank behavior that is difficult to put into practice? As Andrew Haldane, the Bank of England’s director of financial stability said
"…it is possible that no amount of capital or liquidity will be enough to totally shield taxpayers as profit incentives may place risk one step beyond regulation. That means banking reform may need to look beyond regulation to the underlying structure of finance if we are not to risk another sparrow toppling the dominos."
While the UK is pushing for a globally coordinated and administered bank levy, others are moving ahead with national efforts to codify bank levies. National proposals have drawn heavily on the experience of Sweden, where a bank stability fee was instituted in 2009. The Swedish model assesses a levy of 0.018-0.036 percent of liabilities on all banks and other credit institutions. In the near term proceeds of the tax may be used to offset government expenditures due to the current crisis, but subsequent funds will be accumulated in a stability fund, to be used in the resolution of future banking crises. Focusing the bank tax on balance sheets creates incentives for banks to avoid carrying excessive risks on their balance sheets. In January 2010, President Obama proposed a tax on the asset-side of bank balance sheets for large banks (those with assets over US$50b). The German cabinet has agreed tentatively to a bank tax to finance a "stability fund," pending hammering out details through the legislative process. The tax is expected to raise Euro 1-1.2b per year. The proposal under discussion envisions the fee being tailored to the risk profiles of a bank’s balance sheet. Reportedly, French officials will soon follow suit with a similar bank levy plan. Prior to the G-20 meeting, EU finance ministers and central bank chiefs will meet on April 16-17 in Madrid to explore European Union-wide initiatives for a bank levy. Altering bank behavior to avert (or at least to mitigate) future episodes of systemic financial instability should be a leading goal of international financial reform efforts. And there is no reason why the levy should be limited to just one instrument or another when multiple instruments can effectively target different undesirable aspects of the financial system. A levy on excessive leverage on bank balance sheets will encourage banks to better manage risk in their asset allocations while a financial transaction tax can help tamper market volatility and reduce incentives for banks to direct resources toward financial trading rather than lending to profitable, growth-enhancing projects in the real economy. Moreover, a "global" bank tax is not really a global policy, but one focused on and conferring revenue benefits to the developed countries that are home to the world’s "systemically important" (a.k.a. systemically dangerous) banks: the US, UK, France, Germany, Netherlands, Japan, Spain, Canada, and Switzerland. Benefits of a FTT might be more widely distributed across jurisdictions, but even if developing countries fail to receive a share of the FTT revenues, they will benefit directly from reduced price volatility and speculation in their currency-denominated financial assets traded in international financial centers.
IMF Suggests Capital Controls for SE Asia
Not too long ago at the IMF, capital controls on international financial flows were seen as virulent anathema. As recently as November 2009, IMF Managing Director Dominique Strauss-Kahn was saying that capital controls are not a policy recommendation the IMF would recommend. Then the financial crisis sparked some rethinking within the IMF about what constitutes sound macroeconomic and financial policies. In a paper last month, the IMF indicated a new willingness to consider capital controls as a valuable policy tool for managing financial and macroeconomic stability (pdf), at least in theory. But now, at the April ASEAN ministers’ meeting in Nha Trang, Viet Nam, IMF deputy managing director Naoyuki Shinohara suggested that the IMF might get behind the use of capital controls in practice:
"Carefully designed capital controls could also be part of the appropriate response in certain limited circumstances, but these are exceptional measures."
Shinohara’s albeit luke warm support is significant for moving beyond the theoretical support offered to capital controls from the IMF’s research department to raise the potential for supporting capital controls in policy practice. The issue is particularly timely as developing countries explore how to manage an anticipated surge in international financial flows. Developed country financial institutions are awash with liquidity, thanks to the extraordinary interventions taken by monetary authorities in response to the global economic crisis, but potential financial returns in those countries remains very low with low and uncertain near term growth prospects and historically relatively low interest rates. Thus, investors will seek higher returns in the developing countries that are leading the global economic recovery.