G7 Global Bank Tax – GLOBAL???, can it pay the bills and cut financial risk?

At their recent meeting in Canada, G7 finance ministers and central bankers agreed to work with the IMF to develop a global tax on banks to defray bailout costs and reduce global banking's exposure to financial risk .  As of February 10, 2010, UK Prime Minister Gordon Brown seems confident that the IMF will be ready with a global bank tax proposal for approval by the G20 in June.  Maybe that arctic dog sled ride distracted everyone, but it seems like this should be drawing some bigger headlines.  What exactly is a global tax, have we ever had one before and why isn't anyone  excited about it?

Stay calm.  The IMF is not about to turn into the IRS.  Global bank tax is somewhat confusing  shorthand (confusing is an understatement, there's no such thing as a global tax...yet) for a few old ideas which have never been implemented as a package.  What PM Brown has in mind is probably a variation on the Tobin Tax.  In 1972 Nobel-winning Yale economist James Tobin proposed a small tax, no more than one-quarter of one percent, on every currency exchange transaction.  The idea is that a very small transactional fee will discourage high volume, short short-term activity (currency speculation plagued central bankers in 1972), with little impact on the long-term  investor.  The Tobin tax was never adopted.  Brown anticipates that the IMF will propose a similar plan of broader scope, a new tax,  assessed as a very small percentage of a transactions total price, applied not just to foreign exchange, but to a wide range of financial transactions.  Deterring short-term trading and related systemic financial risk is still part of the plan, but now the idea is also to raise revenue and allow the world's governments to  recover some of those bailout costs.

Why “global”?  Much financial activity is borderless.  With some planning, financial institutions can legally shift activity to lower tax jurisdictions. Unless all, or at least most, of the nations that host serious volumes of  financial activity adopt the tax it will become known as the bank relocation tax without producing the desired revenue or long-term, reduced financial risk orientation.   This is a common tax issue, nations have been pledging harmonization and cooperation for years and there is still no such thing as a truly global tax.  Whatever the IMF develops, each G7 or G20 member would need to adopt it separately, using its own, regular legislative process to approve any new tax.    Getting 20 or even 7 countries to adopt the same new bank tax when each has different interests and each is building upon a different preexisting tax structure will be no picnic, to say the least, although the transaction tax approach reduces some of the friction with different preexisting structures.  Even if widely adopted, the global bank tax won't have any impact on tax havens like the Caymans.

Will the global bank tax pass in the US?  What if a few major financial host jurisdictions adopt, but some do not, will the early adopters then repeal rather than lose bank business?  Could the tax be structured like a treaty, not effective until ratified by all the signers (presumably the G20 or some bank heavy subset thereof).  All questions for future posts if the tax progresses. 

 If the G20 get creative they might structure the tax as a user fee wrapped into a formal treaty that includes some provision for international administrative cooperation and some non-binding aspirational regulatory goals.  This could be the first step towards a truly global tax, but the treaty approach would generate heat on both a political and constitutional level in the US.  In a Congress where every new tax is unpopular, a global tax might cause a riot.  Would a user fee in a treaty approach need only Senate approval, as a treaty, or would the full Congressional taxing authority be implicated?

In any case, a global bank tax will create an exciting dilemma for some Tea Party populists – new tax equals bigger government – bad, bad, bad; new tax proposed by international organizations G7 and G20 and developed by IMF – worse, worse worse; new tax to punish fat cat Wall Street bankers, good, good, good.  I see heads exploding.

Photo Credit: John LeGear