## Fair and Substantial—Taxing the Financial Sector

_IMF Blog, April 25, 2010_

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## Bibliographic details
- Authors: Carlo Cottarelli
- Published: April 25, 2010

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### Context and purpose
- IMF was asked by the G-20 to report on “... the range of options countries have adopted or are considering as to how the financial sector could make a fair and substantial contribution toward paying for any burden associated with government interventions to repair the banking system.”
- Objective: take a dispassionate, analytical view of options to raise money from the financial sector to pay for costs of government intervention and to reduce the likelihood and costliness of future crises.
- Interim report prepared for G-20 finance ministers; to be revised for the June 2010 summit.

### Key problems identified
- Governments lacked credible resolution mechanisms for large failing institutions, leaving only two unpalatable options: (1) let a systemic institution fail and bear chaotic fallout, or (2) provide public support, reinforcing “too big to fail.”
- Resolution should mean equity holders wiped out, management replaced, and unsecured creditors take a loss—a process intended to reduce moral hazard.
- Costs of the recent crisis (as estimated in the interim report):
  - Direct support provided by governments: about 2.7 percent of GDP for the group of advanced G-20 countries.
  - Guarantees and other contingent liabilities averaged around 25 percent of GDP for the advanced G-20.
  - Cumulative loss of output of around 27 percent of GDP.
- Indirect fiscal costs from recession and stimulus measures are also significant and contribute to surging public debt.

### Proposed instruments and rationale
- Financial Stability Contribution (FSC)
  - Purpose: ensure financial institutions bear the direct fiscal costs of future failures and to provide upfront cash for resolution to reduce uncertainty for creditors.
  - Design features discussed:
    - Start as a simple levy on some balance sheet (and possibly off-balance sheet) variables.
    - Be refined to strengthen the link with each institution’s contribution to systemic risk to create incentives to reduce that risk.
    - Be permanent (to maintain incentives until regulatory solutions are felt sufficient).
    - Be paid by all financial institutions because all benefit from greater financial stability and the resolution mechanism.
  - Treatment of revenue:
    - Whether revenue is treated as general tax revenue or fed to an earmarked fund is considered secondary for fiscal impact, though a fund could assure ready access for the resolution agency.
  - Interaction with “ex post” charges: FSC would provide upfront funds, with amounts topped up if needed by ex post charges (analogous to the Financial Crisis Responsibility fee proposed in the United States).

- Financial Activities Tax (FAT)
  - Definition: a tax on the sum of the profits and remuneration paid by financial institutions.
  - Economic logic:
    - Profits plus all remuneration equals value added, so a FAT is akin to a Value-Added Tax (VAT).
    - Because financial services are largely VAT-exempt, a FAT could make tax treatment of the financial sector more like other sectors and counteract any tax-driven tendency for the financial sector to be “too large.”
    - If the base includes only remuneration above some high level and profits above a “normal” rate of return, the FAT could approximate a tax on “rents” (returns in excess of competitive levels).
    - Taxing high returns in good times may correct incentives that lead to excessive risk-taking if institutions underweight bad outcomes.

- Financial Transactions Tax (FTT)
  - Definition: a tax paid each time a share, bond, other financial instrument, and/or foreign currency is bought or sold.
  - Assessment in interim report:
    - Some forms of FTT may be feasible and many G-20 countries already tax some financial transactions.
    - FTT is not focused on reducing systemic risk and is not effective at taxing rents in the financial sector; much of the burden may fall on ordinary consumers.
    - The financial industry can devise schemes to get around such a tax (also a concern for FSC and FAT, but suspected to be less severe).
    - Analogy: FAT is like a VAT; FTT is like a turnover tax — VAT generally more efficient at raising revenue than turnover taxes.
    - Conclusion: FTT is not the most effective way to meet the two key objectives (ensure industry bears future fiscal costs; make events less likely and less costly), though it is not ruled out in other contexts.

### Distributional and international considerations
- Countries that did not require large rescues may be reluctant to impose additional charges on their financial sectors.
- Concern about tax and regulatory arbitrage across jurisdictions if some countries act and others do not.
- Counterpoints:
  - No country is immune from failures and crises.
  - If FSC is properly risk-adjusted, countries with safer systems would face smaller contributions.
  - Avoid imposing such heavy burdens that they repress the financial sector and harm economic growth; the financial sector provides many beneficial services.

### Policy priorities and next steps
- Core priorities:
  - Create credible resolution mechanisms so owners and managers bear losses and moral hazard is reduced.
  - Ensure the financial sector contributes to the cost of resolution and crisis prevention through instruments like the FSC and FAT, with careful design to target systemic risk and rents.
  - Coordinate tax initiatives with regulatory reforms.
- Process:
  - The IMF will revise the interim report for the June summit based on G-20 finance ministers’ discussions.
  - IMF will continue to listen to stakeholders and conduct further number-crunching to refine options and assess interactions with regulatory measures.
- Overarching aim: reduce the risk, and costliness, of future financial failures.

*IMF blog post by Carlo Cottarelli, April 25, 2010.*

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_Source: https://www.imf.org/en/blogs/articles/2010/04/25/fair-and-substantial-taxing-the-financial-sector_