Taxation Of Financial Institutions

THE FUTURE OF BANKING

Solving the current crisis

Thorsten Beck

Tilburg University and CEPR

For better or worse, banking is back in the headlines. While in 2008 financial institutions “caused” the crisis and triggered widespread bailouts followed by fiscal stimulus programmes to limit the fall-out of the banking crisis for the rest of the economy, banks now seem to be more on the receiving end. The fact that banks are yet again in trouble shows that the previous crisis of 2008 has not been used sufficiently to fix the underlying problems. After a short period in crisis mode, there was too much momentum to go back to the old regime, with only minor changes here and there.

Before discussing in more depth the main messages of this eBook, it should be noted three headline messages:

1. We need a forceful and swift resolution of the Eurozone crisis, without further delay! For this to happen, the sovereign debt and banking crises that are intertwined have to be addressed with separate policy tools. Now it is time to follow up on this insight and to be resolute.

2. It’s all about incentives! We have to think beyond mechanical solutions that create cushions and buffers but be shaped in a way that forces financial institutions to internalise all repercussions of their risk, especially the external costs of their potential failure.

3. The interaction between banks and regulators/politicians is a multi-round game. As any game theorist will tell you, it is best to solve this from the end. A bailout upon failure will provide incentives for aggressive risk-taking throughout the life of a bank. Only a credible resolution regime that forces risk decision-takers to bear the losses of these decisions is an incentive compatible with aligning the interests of banks and the broader economy.

Taxation Of Financial Institutions

For many years, taxation of financial institutions was a topic for specialists, as much among tax or public finance economists as among financial economists. The current crisis and the need for large recapitalisation amounts for banks have changed this dramatically, and taxation for banks now forms part of a broader debate on regulatory reform. Proposals to introduce a financial transaction tax, in one form or another, have emerged in the political arena over the past three years with a regularity that matches seasonal changes in Europe. Banks are under-taxed, but there are better ways to address this gap, such as eliminating the VAT exemption on financial services or a common EU framework for bank levies. Among the global top 25 banks (as measured by market capitalisation), there are 8 emerging-market banks, including 4 Chinese, 3 Brazilian, and 1 Russian. Due to their sheer size, emerging-market banks will almost undoubtedly soon become important players in the world’s financial system. And given that US and European banks are still to adjust to the new rules of the game, large banks from the emerging countries are likely to step into the void left by advanced-country banks. There will be a continuing shift towards emerging markets also in banking!

The topic of taxation of financial institutions is very controversial, like every attempt at introducing a new tax. The opponents of the financial transactions tax claim that the direct result of its introduction would be a very easy escape of the most of easy to tax capitals and transactions to the outside of the EU. Even the EU Commission presents this initiative as a start to a global reform which will be continued by others. It will be difficult to arouse international enthusiasm in this matter.