economics

April 21, 2010

IMF to Nations: Tax Finance Firms

By BOB DAVIS

WASHINGTON—The International Monetary Fund advised Group-of-20 nations to tax balance sheets, profits and compensation of financial institutions to reduce the chances of another financial crisis, and pay for the costs if one occurs.

“Expecting taxpayers to support the [financial] sector during bad times while allowing owners, managers and/or creditors of financial institutions to enjoy the gains of good times misallocates resources and undermines long-term growth,” the IMF wrote in a briefing paper for the G-20 industrialized and developing countries.

Specifically, to pay for the costs of winding down troubled financial institutions, the IMF proposed what it called a Financial Stability Contribution”—a tax on balance sheets, including “possibly” off-balance sheet items, but excluding capital and insured liabilities.

That tax would seek to raise between about 2% to 4% of GDP over time—roughly $1 trillion to $2 trillion if all G-20 countries adopted the tax. Initially the FSC would be a flat fee paid by a broad range of financial institutions. But over time the fee could be adjusted to reflect the “riskiness” of an institution and its “contribution to systemic risk,” the IMF said.

On top of that, the IMF proposed that nations to adopt what it called a Financial Activities Tax, levied on the sum of profits and compensation of financial institutions. That would be paid to a nation’s treasury to help finance the broader costs of a financial crisis.

The FAT is also designed to reduce the size of the financial sector so it is more manageable and its failures were less likely to batter economic growth.

The proposal, which was initially disclosed by British Broadcasting Corp., is sure to play a major role in political and economic debates in the U.S. and Europe, where a number of countries are pushing for various bank taxes and resolution authorities.

Britain, which had been lobbying nations for more than a year to adopt such financial levies welcomed the proposal. “The recognition that banks should make a contribution to the society in which they operate is right, ” said U.K. Treasury chief Alistair Darling.

The leaking of the report makes certain that the bank tax will become a focal point of a G-20 finance ministers meeting on Friday and an IMF meeting during the weekend. It was far from clear that the G-20 would have made the report public otherwise, especially since Canada opposes any bank tax and is hosting the next G-20 leaders session in June.

In the U.S., the administration and Congress are considering milder versions of a bank tax than the IMF contemplates. U.S. officials said the IMF was playing a “useful role,” but didn’t comment directly on the report.

The IMF proposal is meant to advise countries with very different political and economic systems how they might structure a bank tax. Some European countries, like France, almost never close down large banks.

The IMF said that a nation didn’t need to put in place a specific resolution authority. Instead, the tax money could go to general revenues and used in case of financial crisis. But the IMF warned that the money would be spent by the time a problem arose.

Critics of resolution authorities, however, argue the opposite—that the existence of a well-funded mechanism for shutting down financial institutions would spur banks to take risky behavior. That’s because they may believe that in a pinch, governments would use the money to keep them alive rather than to shut them. The IMF proposal leaves open the possibility that a failing bank could be kept alive, although shareholders and lenders would be expected to take big hits and management would be replaced.

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