Shrinking the Finance Industry With a Financial Activities Tax

Carlo Cottarelli at the International Monetary Fund’s blog (yes, the IMF has a blog) makes the case for a Financial Activities Tax:

A FAT is just a tax on the sum of the profits and remuneration paid by financial institutions. That sounds simple, and, in essence, it is. But why an extra tax on financial institutions? Here, I’m afraid, things get a bit nerdy. So brace up for what is coming.

Profits plus all remuneration is value added. So a tax of this kind would be a kind of Value-Added Tax or VAT. And that could make sense because current VATs don’t work well for financial services, which are largely VAT-exempt. This means that a FAT of this kind could make the tax treatment of the financial sector more like that other sectors and so help offset a tendency for the financial sector, purely for tax reasons, to be too large — or too fat.

The case for cutting banking down to size strikes me as more compelling than the case for shrinking any particular bank. What’s more, taxes in the future are clearly going to have to be higher than taxes are today, so this seems like a compelling way to achieve that goal.