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Paying for the crisis: IMF staff reject the FTT (in favour of a financial activities tax)
22 April 2010
By Bodo Ellmers
Ahead of the Spring Meetings of the IMF and World Bank, the IMF has delivered its interim report to the G20. The report outlines several options for how the financial sector can be made liable for at least some of the costs caused by the crisis, which are currently borne by taxpayers. Not surprisingly, the IMF staff reject the ambitious proposal of introducing a general Financial Transaction Tax (FTT). They opt for bank levies and a VAT-like Financial Activities Tax (FAT) instead.
The costs of the crisis are currently borne by the general public
The financial crisis, triggered by an under-regulated financial sector, has been a costly endeavour for public households. The fiscal cost of direct support has averaged 2.7 percent of GDP for advanced G20 countries. But these costs could still increase since public guarantees for the financial sector, many of which are still in place and might be needed for struggling banks, account for 25% of GDP. As a result of the crisis, government debt in advanced G20 countries is expected to rise by almost 40 percentage points of GDP during 2008-2015. Thus, taxpayers and citizens will feel its impact for many years to come, when a large share of tax income will not be used for financing public goods that serve the citizens, but rather for paying off debt.
The G20’s options for making the financial sector pay for the cost of the crisis
The G20 have therefore mandated the IMF to prepare a report “on the range of options countries have adopted or are considering regarding how the financial sector could make a fair and substantial contribution toward paying for any burden associated with government interventions to repair the banking system.” The Interim Report for the G20 entitled “A fair and substantial contribution by the financial sector ” has now been published in time for the G20 Finance Ministers meeting in Washington.
In its paper, the IMF staff maps different measures adopted or considered by G20 governments to reclaim at least a part of the costs from the financial sector and its responsible managers. These include temporary bonus taxes as introduced by France and the UK, a Financial Crisis Responsibility (FCR) fee of 0.15% of covered liabilities of financial institutions, as proposed by the US government, and last but not least a financial transaction tax supported by a number of governments, including in Belgium, France and Austria, and a large coalition of civil society organisations.
For the IMF, strengthened regulation is insufficient to prevent financial institution failures
The IMF staff emphasise that even strengthened regulation will not fully be able to prevent failures of financial institutions and their eventual costs to public budgets. They largely agree that the financial sector needs to be made liable for these costs, to avoid the moral hazards of bankers taking the profits while times are good, but socialising the losses in times of failure. Bailing-in the financial sector is also essential to maintain political support for future rescue packages, when they are needed.
Under the criteria used that: one, any new measures should be easy to implement, two, the financial sector should contribute to the costs of financial crises, and three, any measure should address existing tax distortions such as the favour for debt (whose costs are tax deductible) over equity (whose yields are taxed), the IMF comes to the following conclusions:
Backward-looking taxes, and bank levies
Backward-looking taxes, taxes paid by each financial institution on assets (or other adequate balance sheet variables) held at a certain point in the past, would be the least distortionary way to recover some of the costs of the financial sector bail-outs, say the IMF staff. They are also in favour of bank levies, whose revenue might flow to either feed into general public revenue, or flow to a resolution fund. However, they admit that the revenue potential of these levies is small compared to other proposed measures such as the FTT. This is why a revenue fund might need to have access to contingent credit lines in order to cope with larger bank failures, and the levies might be supplemented by recovery charges after a crisis has occurred, to recover the full costs.
Financial Transaction Tax - the pros, the cons, and why the IMF is rejecting it
There is almost no positive statement in the paper on the FTT, despite the numerous favourable arguments put forward by experts who laud the FTT for both its revenue potential and regulatory effects. On the upside, the IMF staff agree that it is feasible from an administrative point of view, and that it may raise up to US$ 200bn annually at a tax rate of 0.1%. But the remaining space dedicated to debating the FTT is exclusively used for turning down the arguments put forward by the many proponents of the FTT. According to the IMF staff position, the FTT as a general transaction tax is inadequate because it does not exclusively focus on core sources of financial instability. They also say that the costs may be handed on to the consumers instead of reducing the profits of the financial industry.
Proponents of the FTT, however, argue that the lion’s share of financial transactions happen among financial institutions and are of a purely speculative nature. They do not involve any consumers. Moreover, speculation is one of the core sources of financial instability, and the FTT would significantly reduce incentives for speculative transactions; besides, FTT would ensure the traceability of financial operations, which is essential to track illicit and illegal financial practices and tax evasion.
The Financial Activities Tax (FAT)- the IMF’s alternative to the FTT.
Rather than an FTT, the IMF staff propose a Financial Activities Tax (FAT). This tax would be levied on profits and remunerations in the financial sector, rather than on the transactions themselves. As such, it has almost the same character and impacts as the sales tax (VAT) has for non-financial products. In effect, it would reduce the size of the financial sector as a share of the total economy, because it would make financial services more costly by reducing the favourable treatment they enjoy under current VAT regimes (which mostly do not cover financial services). This proposal has therefore some positive aspects. But overall it remains weaker than the FTT and leaves some open questions:
Why the FAT is not enough
Firstly, the revenue would only be substantial in countries with a large financial sector; they estimate revenue of 0.1%- to 0.2% in the UK, at a tax rate of 2%. Thus, the revenue would be much smaller than that of the FTT. Furthermore, the IMF staff do not answer how this meagre revenue could recover the costs of the financial bail-outs, which the same authors in the same paper estimate to be 5.4% of GDP for the UK. Thus, if the UK government follows the IMF staff’s proposal rather than opting for the more fruitful FTT, it would take between 27 to 54 years until they have recovered their citizen’s money.
Despite these shortfalls the IMF staff still consider a combination of the FAT and bank levies to be the way to make the financial sector contribute to the costs of the crises. This is because the impact of this combination on financial markets is more predictable, it would also be clearer who will eventually have to bear the costs, and it would be easier to implement.
Two taxes are better than one
For a relatively conservative institution such as the IMF, the FAT proposal is definitely a step forward. However, in a time where the world is struggling to recover from a severe economic and financial crisis which has impoverished tens of millions in the South and North, a more ambitious approach from the IMF is still needed. In fact, for policy makers at the G20, the question is not either/or. To recover the bank bail-out funds, to create tax justice and regulate the financial market, we need both – the Financial Activities Tax and the Financial Transaction Tax.