15
Jan
10

Further to that bank tax

Greg Mankiw says what I was trying to say, only better and with more examples:

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.

In the presence of a government subsidy, firms tend to over-expand beyond the point of economic efficiency.  In particular, the expectation of a bailout when things go wrong will lead large financial institutions to grow too much and take on too much risk.

[…]

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.

Will the tax law in fact be so well written?   It certainly won’t be perfect.  But it is possible that it will be better than doing nothing at all, watching the finance industry expand excessively, and waiting for the next financial crisis and taxpayer bailout.

RTWT.  Still based on the assumption that only the “too-big-to-fail” banks that received TARP funds will pay the new tax — or, as Mankiw points out, that the bank tax is a preëmptive effort to offset incentives from future bailouts.  (Will the latter interpretation backfire?  I can see banks treating this as a finance-sector Social Security programme: “We paid the bank tax, so we’ve earned a bailout!”)

“It might be better than doing nothing at all” is about as optimistic a conclusion as I can find.

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