TARP Tax Is By No Means Big Enough

I’m in favor of the bank tax; what’s not to like about extracting $117 billion from large banks to pay for the net costs of TARP? But it’s by no means enough.

Simon covered the main points earlier this morning, so I’ll just add three comments.

1. Why $117 billion? Because that’s the current projected cost of TARP. But everyone realizes that TARP was only a small part of the government response to the financial crisis, and the main budgetary impact of the crisis is not TARP, but the collapse in tax revenues that created our current and projected deficits. So why not raise a lot more?

2. The tax isn’t going to prevent a future financial crisis. And it isn’t going to hurt any bankers, at least not very much. Basically it will get passed on to customers, and shareholders will take a small hit. The best thing about the tax is that it helps level the playing field between large and small banks. From Q4 2008 through Q2 2009, large banks had a funding cost that was 78 basis points lower than that of small banks, up 49 basis points from 2000-2007. Closing that gap could lead some of those customers, faced with lower interest payments on deposits or higher fees, to take their money elsewhere. (Of course, they are already getting lower interest and paying higher fees, so there may not be much of an effect.)

But the tax isn’t nearly big enough! It’s being calculated as 15 basis points of uninsured liabilities, calculated as assets minus Tier 1 capital minus insured deposits. 15 basis points is a lot less than 78 basis points. And if the FDIC cost of funds data are based on all liabilities (not just uninsured liabilities),* then charging 15 basis points on uninsured liabilities only increases the overall cost of funds by about 7 basis points (at least in the administration’s example). This doesn’t come close to compensating for the TBTF subsidy.

The big banks will fight this, of course; they will claim that it simply increases the costs of doing business in America (although most individuals or firms can avoid those costs simply by switching banks. From a PR perspective, they would probably be better off smiling and handing over the money; if all they have to fear is a tax of 6 bp on total assets (again, in the administration’s example), then they really have nothing to fear.

3. Because it’s a flat tax with a cliff at $50 billion in assets, it isn’t going to provide an incentive for banks themselves to get smaller; Bank of America (BAC) is not going to break itself into 45 pieces to avoid a 6 bp asset tax. If the tax had been graduated (bigger banks pay a higher percentage), then it might have had some small effect, although again the tax is probably way too small.

* I couldn’t tell in the fifteen minutes I spent on the FDIC web site–as I’ve often noted, what an awful web site! The Federal Reserve wins that contest hands down.

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