If this were not an opinion about government policy, the title of this piece would be confused for a work of literature, albeit of the copycat variety. The reason for it to not sound as literary as “Sense and Sensibility” is that its purpose is to illustrate the dissonance it is about to describe.
Reality can be more interesting than fiction. The government, it is reported, is considering fees on banks which are being hectored in the public for the fees they charge others. The rationale seems clear: to cut the budget deficits using the profits of the fat cat bankers, because those profits are causing the government to incur the deficits. The moral of the story behind the tax proposal seems to be to signal to the bankers to not profit without benefiting the society also. The intent is noble, but the method may not work.
It is entirely possible that the profits of banks would be squeezed, at least in consumer banking if not in wealth management, if the banks are asked to pay a fee. The banks are already being charged with fee fleecing, so they won’t be able to raise them anymore on their depositors for the services they provide. They usually compete with interest rates, so they cannot raise rates either. To reduce bank fees the commercial banks must be forced to compete with credit unions so that banking and other financial services are available across the entire income distribution, from low income neighborhoods to the fancy Upper East Side of Manhattan. Imposing fees on commercial banking is a bad idea.
Currently, the need for revenue in Washington is motivating extraordinary innovation to tweak the tax code into layers of incoherent lasagna both on top of and interspersed with the existing layers. “How smart is Peter Orszag?” to get it done asked one newspaper, as if the health care hype of the young nerd was not enough for this administration. The Director of the Office of Management and Budget had reversed the Bush tax cuts stealthily in the health care reform bill which has not yet become law because it cannot cut healthcare costs. But to cut the budget deficit much more must be done: it is also known in Washington, since time immemorial, as “government reform” of a government whose price only seems to know how to go up but never come down, no matter who is in charge of this town, Democrat or Republican.
The taxes an American pays today are dependent on what kind of tax expertise he or she has access to, ranging from H&R Block to personal and corporate tax lawyers. It is an ecosystem that thrives on the ambiguities and the fabricated complexities of the tax code. This music has to be faced if reality is to be changed. Depending on which types of financial activities would be subject to the proposed fee, the fees for those transactions could rise for customers in those markets. It appears that the administration has in mind what in the economics profession is known as a Tobin Tax on financial transactions in the non-commercial banking sector. It is the equivalent of the sales tax on consumer goods.
The Tobin Tax per se is not a bad idea. What matters is how it is integrated into the structure of the U.S tax system which is in disrepair similar to the country’s aging infrastructure. And tax overhaul is not a bad idea to take up together with overhauling financial regulations because the capital levels that banks are required to hold, the non-working capital, are also a form of tax. The financial system, similar to the non-financial part of the U.S economy, is also a giant value chain. Along the way, different suppliers and buyers of financial services specialize in different kinds of activities. Each activity is sold and bought and has a price just as an automaker only makes cars but buys everything else from his or her suppliers ranging from raw materials to intermediate goods to the finished cars he or she makes on the automaker’s factory floors. The Tobin tax on financial transactions is the equivalent of a tax on the value added at each stage of processing a product, from the beginning to the end. It is a form of a value added tax (VAT).
Much has been said for a long time about the need for the United States to adopt a VAT in lieu of corporate taxes (not in addition to them), and there is substantial consensus on the matter among those who are not part of the tax ecosystem: the lawyers and accountants who earn a handsome living in New York and Washington helping the Congress manipulate the tax code as a win-win matter for both appropriations and corporations. So, the government taking a hard look at shifting from the corporate tax structure to a VAT structure is a good idea.
As to instilling a sense of self-responsibility on Wall Street which has lately gotten used to earning well whether it is wrong or right, the government can levy a refundable contingency tax on all financial institutions by size in lieu of wrangling with them ad nauseum over minimum capital levels and the complex global gymnastics over a legislation known as Basel II which not even the regulators understand let alone the bankers. The financial institutions on Wall Street and elsewhere will then be asked to pay a simple and flat/progressive tax, based on what they do and how big they are. It will be refunded when they need it, with interest, to bail themselves out before coming hat in one hand to the government while holding the American economy by the jugular in the other, strictly as a last resort.
Reforming financial regulations will not cure the bonus disease nor will executive wage controls because executives cannot obviously pay tens of thousands of dollars in political campaign donations if their wages are restricted from some tens of millions per year to mere millions. The campaign contributions could deteriorate to a trickle of a few thousands, also by an order of magnitude. In these games at the top nothing has trickled down yet to the average worker but much has been taken away from him.
Ideally, workers on Wall Street, similar to most of the rest of us which includes the elected representatives, must be on a salary. After all, they don’t need to increase their incomes by their habitual amounts of at least more than 10% per year for doing the same thing year after year, especially after they have been handsomely rewarded all these years for all that innovation which was as awesome (for them) as it was awry (for the rest of us mere mortals). They have been duly compensated for spinning money. So, it is time to move on into the reality of normal salarydom from beyond the clouds of the financial pyramid scheme that has made them forget where their feet stand because the government has been holding them above ground for its benefit at the expense of the people as if in the United States “one person one vote” does not mean votes of the same importance. Then, the price of receiving the education to work on Wall Street which has been going up commensurately with the bonuses, skewing American human capital away from what the country really needs: more scientists, engineers and doctors, will also come down, and in the process will correct the salaries of those who really need to be paid if Wall Street is to stay employed in the foreseeable future. To keep their jobs they must invest, not to do us all a favor.
Should Wall Street salaries rise when they are deprived of bonuses (they won’t because profits are always uncertain if the government behaves) there is always the multiple tax which was briefly floated by John Edwards during his Democrat primary campaign: tax all total realized annual compensation more than a certain multiple of that of the lowest paid worker in any corporation, Wall Street or Main Street, at a prohibitively high rate (after all, the top marginal tax rate before JFK was 90%). Executives can then earn all they want as long as they pay everyone else fairly. The country will then not need the minimum wage, let alone a presidential pay cap for Wall Street. In government this multiple is 10: ranging from the lowest paid government civil servant to the President of the United States. In the free market 100 sounds like a reasonable number, so that those playing by the rules who are subject to a multiple of 10, which is most of the United States, are not priced out of their own country that wants to turn into a Shangri La for the rich and famous, similar to Switzerland and Monaco, from sea to shining sea: banking by day and gambling by night.
The justifiable populist anger over this economic crisis can be met with equitable reforms and therefore it must be.