How Big a Bank Tax?

James Kwak wants to see a heftier fee levied on large banks, calculating thusly:

The tax isn’t going to prevent a future financial crisis. And it isn’t going to hurt any bankers, at least not very much. Basically it will get passed on to customers, and shareholders will take a small hit. The best thing about the tax is that it helps level the playing field between large and small banks. From Q4 2008 through Q2 2009, large banks had a funding cost that was 78 basis points lower than that of small banks, up 49 basis points from 2000–2007. Closing that gap could lead some of those customers, faced with lower interest payments on deposits or higher fees, to take their money elsewhere. (Of course, they are already getting lower interest and paying higher fees, so there may not be much of an effect.)

But the tax isn’t nearly big enough! It’s being calculated as 15 basis points of uninsured liabilities, calculated as assets minus Tier 1 capital minus insured deposits. 15 basis points is a lot less than 78 basis points. And if the FDIC cost of funds data are based on all liabilities (not just uninsured liabilities),* then charging 15 basis points on uninsured liabilities only increases the overall cost of funds by about 7 basis points (at least in the administration’s example). This doesn’t come close to compensating for the TBTF subsidy.

A couple of points on this. One is that insofar as both large and small banks exist, any levy that specifically falls on large banks does in fact hurt them. I don’t think it makes sense to look at the 78 basis point funding gap (“78 basis points” means “0.78”) and conclude that a 77 basis point tax is too small to “prevent a future financial crisis” whereas as 79 basis point tax would be big enough. A tax of any size has an impact at the margin. A bigger tax would have a bigger margin.


The other is that a tax arguably shouldn’t be the main way we tackle the “too big to fail” subsidy and it certainly shouldn’t be the only way. The problem we faced in 2008 is that the process spelled out in the Bankruptcy Code doesn’t work for financial institutions and the FDIC process doesn’t apply to these kind of companies. This is a problem that needs to be tackled head on through legislation that sets some kind of workable rules up in advance. That will then set up a situation where nobody is “too big to fail,” but the details of how you work it out will determine what failure amounts to. At that point you’d need to redo the whole calculation again of whether or not big banks are getting an implicit subsidy.

But this brings me back to my previous point that starting in 2012 or 2013 we’re going to need higher taxes one way or the other. That’s going to be a tough, tough, tough political fight. A tax on large banks seems like a relatively winnable tax fight. But it’s not an easy one! Even with this small tax on the table, banks are prepared to fight it and conservatives in congress are eager to go to the mat in defense of the banks. If you can beat them, then why not do it in a way that raises a much more substantial chunk of revenue? Why not at least try? We really don’t know where the pivotal members of congress stand on this, and the administration is opening with a very low bid