The Bank Tax Revisited: A Closer Look At President Obama's Proposed Bank Tax To Recoup TARP Losses

In my post today, as a follow-up to Professor cumming's excellent post yesterday, I want to take a moment to revisit President Obama's bank tax proposal. I've uncovered some interesting data that explores the direct impact of the bank tax on a handful of big financial institutions like Citigroup, Bank of America, JP Morgan, Goldman Sachs, and Morgan Stanley.

On Thursday, President Obama announced a bank tax plan designed to tax roughly 50 of the largest banks and financial institutions over the course of the next decade to recoup losses associated with the bailout of Wall Street. Smaller community banks won't be affected by the bank tax. President Obama stated that his goal over the next decade is to “recover every single dime” from the TARP bailout of Wall Street. President Obama hopes to officially include the so-called “bank tax” provisions in February when he proposes his budget plans to Congress.

Who will be covered by the bank tax? The tax, if adopted, will be levied on banks, insurance companies and brokerages with more than $50 billion in assets, and would start after June 30, 2010. The bank tax would not apply to bank customer’s insured accounts, but rather it would apply to assets used as part of the institution’s risk-taking operations and activities. The goal that President Obama seeks to reach is to recoup roughly $90 billion over a ten (10) year period. The bank tax could remain in effect for over ten (10) years if losses from TARP are not recovered after a decade. At the moment, Obama Administration officials suggest that TARP will likely be about $117 billion, which is roughly 1/3 of the losses that officials projected last summer. The lion’s share of the TARP losses are associated with the bailouts of Chrysler, General Motors, and AIG.

In delivering his remarks on Thursday, President Obama noted: “We’re already hearing a hue and cry from Wall Street suggesting that this proposed fee is not only unwelcome but unfair…That by some twisted logic it is more appropriate for the American people to bear the cost of the bailout rather than the industry that benefited from it, even though these executives are out there giving themselves huge bonuses.” President Obama continued: “What I say to these executives is this: Instead of sending a phalanx of lobbyists to fight this proposal or employing an army of lawyers and accountants to help evade the fee, I suggest you might want to consider simply meeting your responsibilities”

Naturally, big banks have bulked at the bank tax. Their argument is that they have paid back their TARP allocations with interest. In anticipation of this argument, the Obama Administration noted that the bank tax is in a sense a “financial crisis responsibility fee” aimed at policing those institutions whose risky behavior started the financial crisis in the first place.

Will the bank tax be passed on to consumers? The answer is to a certain extent yes. However, by exempting smaller community banks if large banks increase their fees too drastically savvy smaller banks will likely draw a line on their fees to attract customers of higher fee large banks. In many ways President Obama’s proposal drives a wedge between small and large banks. Due to their exemption from the bank tax, small community banks will likely support the Obama proposal at the cost of their larger brethren.

Practically speaking, how would the tax impact financial institutions like Citigroup, JPMorgan Chase, Bank of America, Goldman Sachs, and Morgan Stanley? Analysis shows that Citigroup would a roughly $2.2 billion per year assessment. Both JPMorgan Chase and Bank of America would face an annual assessment of $2 billion. Similarly, Goldman Sachs and Morgan Stanley would pay assessments in the same ballpark. The bank tax would amount to a roughly $1.5 million tax on every $1 billion in institutional assets subject to the tax or levy. Again, Tier 1 capital, including common stock, and insured customer deposit accounts, for which banks already pay fees to the Federal Deposit Insurance Corporation (“FDIC”), would not be subjected or exposed to the bank tax.

In a mid-term election year President Obama’s bank tax proposal taps into popular angst and distrust of large financial institutions on both sides of the political aisle. Philosophically, most fiscal conservatives are opposed to taxes in almost any form during a recession. Interestingly, Republicans have not been so quick to criticize the bank tax fearing that they may draw the ire of their own political base and remaining mindful of the fact that small community banks, which may benefit, exist in virtually every Congress member’s district. President Obama is tapping into populist angst that cuts across party lines—Citizens are angry about the role that large banks played in nearly pushing our economy over the abyss through uncontrolled risk-taking.

Obama Administration Talks Tough

The Obama administration appears finally to be getting serious about financial industry reform. Last week President Obama proposed a new tax to be levied on the nation’s largest financial institutions to pay for the unrecovered portions of the TARP bailout while leaving smaller community banks unaffected. Yesterday, the President announced new "too big to fail" financial regulation policies that promise to regulate the financial sector in ways that appear to protect against similar recurrences of the bank executive recklessness that precipitated the financial market crisis.

The bank tax proposal intends to raise up to $117 billion from large financial institutions and banks that hold more than $40 billion in assets and would not apply to holdings like customers’ insured savings but rather assets used in risk-taking operations. While many suggest that this plan, together with yesterday's announcement that a financial system overhaul would be undertaken, is an attempt to tap into the populist anger against the bank bailouts seen most recently in the outcome of the Senate election in Massachusetts. While politics may drive politicians to favor this new bank tax, the merits of the policy suggest that many should strongly favor its passage on the merits. Harvard economist Greg Mankiw describes the rationale behind the tax:

One thing we have learned over the past couple years is that Washington is not going to let large financial institutions fail. The bailouts of the past will surely lead people to expect bailouts in the future. Bailouts are a specific type of subsidy—a contingent subsidy, but a subsidy nonetheless . . . .

What to do? We could promise never to bail out financial institutions again. Yet nobody would ever believe us. And when the next financial crisis hits, our past promises would not deter us from doing what seemed expedient at the time.

Alternatively, we can offset the effects of the subsidy with a tax. If well written, the new tax law would counteract the effects of the implicit subsidies from expected future bailouts.

Government’s enormous subsidy of the financial sector through TARP is evidenced by the almost instantaneous turn-around of financial institutions on the brink of collapse last year reporting record profits in recent months. This bank tax offers a way to offset the subsidy. As the largest banks argue that this tax will limit their ability to make loans to small businesses and everyday consumers, such posturing lays bare the banks’ hypocrisy. Instantaneous recovery and accompanying record bonuses occur on the backs of U.S. taxpayers as TARP funds were horded by big banks to bolster balance sheets, rather than used to free up severely tightened credit markets.

Despite intense public scrutiny and pressure, big banks appear unwilling to accept this tax as an opportunity to repay taxpayers despite the obvious eventuality that these costs would likely be passed on to customers. Wall Street’s main lobbying arm has hired Carter G. Phillips of Sidley Austin to investigate whether the punitive nature of the tax focusing on big banks violates the Constitution. The fighting and lobbying appears to just be cranking up in opposition. President Obama has responded to these challenges saying, “Instead of sending a phalanx of lobbyists to fight this proposal or employing an army of lawyers and accountants to help evade the fee, I suggest you might want to consider simply meeting your responsibilities.”

This blog will undoubtedly unwind and debate the merits of yesterday's new financial regulatory overhaul announcement in coming days . . . .