The Taxation and Regulation of Banks

IMF Working Papers, August 1, 2011

Source details

Examines the structure, appropriate rate, and revenue yield of corrective taxation of financial institutions in response to externalities from excessive risk-taking.
Addresses two externalities highlighted by the financial crisis:
- Externalities that arise when financial institutions are allowed to collapse.
- Externalities that arise when creditors are bailed out to avoid broader harm.
Compares corrective taxation with regulatory capital requirements as mechanisms to address these externalities.
Notes that several countries have introduced bank taxes: France, Germany, the United Kingdom, and several other European countries; the U.S. administration has revived its own proposal for such a charge.

Suggests a potential role for taxing bank borrowing as a corrective measure, possibly as an adjunct to minimum capital requirements.
Recommends marginal tax rates on bank borrowing that:
- Rise quite sharply at low capital ratios.
- Are likely lower when the government cannot commit to its bailout policy.
- Could reach levels higher than those of the bank taxes so far adopted or proposed.

Corrective taxation can be considered alongside regulatory capital requirements rather than as a mutually exclusive alternative.
Taxing bank borrowing targets the externalities from both failure and bailout risk, with marginal rates designed to discourage excessive leverage—especially when capital ratios are low.
The appropriate design should account for the government’s bailout commitment, as inability to commit reduces the effective corrective tax needed.