Minneapolis Federal Reserve President Narayana Kocherlakota is calling for a U.S. tax on financial institutions to limit the cost what he called “inevitable” future government bailouts.
In remarks to the Economic Club of Minnesota on Monday, Kocherlakota said: “My theme today is that, although bailouts are inevitable, their magnitude can be limited by taxes on financial institutions. I arrive at this conclusion about the usefulness of taxes by thinking through an analogy that I’ll develop at some length. I will argue that, knowing bailouts are inevitable, financial institutions fail to internalize all the risks that their investment decisions impose on society. Economists would say that bailouts thereby create a risk “externality.” There is nearly a century of economic thought about how to deal with externalities of various sorts—and the usual answer is through taxation. I will suggest that the logic that argues for taxation to deal with other externalities is exactly applicable in this case as well. As always, any views I share today are my own, and not necessarily those of others in the Federal Reserve System.” [Minneapolis Fed]