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The Real Economic Consequences of Obama's Bank Tax Plan

Politics / US Politics Apr 05, 2010 - 08:51 AM GMT

By: Money_and_Markets

Politics

Best Financial Markets Analysis ArticleMonty Agarwal writes: President Obama plans to introduce a fee on the largest banks in the country — those with assets greater than $50 billion — in an effort to get back “every single dime” for the taxpayers. This levy will start June 30 and aims to collect $90 billion over a course of 10 years.


But increasing taxes in time of economic weakness is exactly what is not needed!

Even if the taxes are targeted at banks, the ripple effect of these taxes will be felt throughout the economy as it will directly reduce the aggregate demand by the amount of taxes collected. Additionally, targeted taxation at the banks to “punish” them does not serve its purpose as the taxes end up getting passed to the consumers in various forms.

Therefore, the logical conclusion would be that with the mid-term elections coming up in November and unemployment still hovering around 10 percent, this move seems to be driven more by politics rather than pure economic sense.

Now let’s examine some of the …

Other Obvious Ramifications of the Obama Tax Plan …

The tax plan is targeting large profitable banks, such as Goldman Sachs and JP Morgan. Taxes collected from these profitable ventures are and will continue to be funneled to subsidize badly run businesses like AIG and GM.

New taxes will continue to prop up mismanaged companies.
New taxes will continue to prop up mismanaged companies.

As any first year economics student will tell you, tariffs and subsidies result in creating “deadweight loss.” This deadweight loss results in a loss of economic efficiency, which often leads to price inflation and lowering a country’s GDP.

The U.S. economy is highly dependent on credit, whether it’s for mortgages, credit cards, student loans or small business loans. Given this massive dependence on credit, Wall Street’s recovery always precedes Main Street’s recovery. Meaning that as banks’ balance sheets improve, their risk-taking ability increases and they are more willing to make loans.

Increasing taxes on banks will impact their bottom line. And even if they are able to pass these taxes onto the consumer, there will be a delay in doing so and some loss of business.

This is bound to increase the banks’ risk averseness, consequently reducing their willingness to make loans. Ultimately it will have a direct adverse effect on the economic recovery.

Next, let’s look at …

Some of the More Subtle Ramifications …

Since the new taxes on big banks are bound to affect their bottom line, their ability to attract, compensate thereby retain top talent will be curtailed. The biggest beneficiaries of this talent outflow from the big banks are going to be the smaller banks, hedge funds and private equity firms.

I would also expect to see more financial institutions lean towards becoming privately-held partnerships to avoid the bureaucratic clutches of the government. This will not only reduce the number of institutions that will be under the regulatory oversight, but also move more risk taking to unregulated institutions like hedge funds and privately held banks.

The net result: An increase in systemic risk.

In my opinion, bank bailouts followed by misguided tax policies to appease the populace create the wrong incentives for the future. A better solution might be something that we had in place for 66 years, the Glass-Steagall Act of 1933 …

On June 16, 1933, President Franklin Roosevelt signed the Banking Act of 1933, a part of which established the FDIC. At Roosevelt's immediate right and left were Sen. Carter Glass of Virginia and Rep. Henry Steagall of Alabama, the two most prominent figures in the bill's development.
On June 16, 1933, President Franklin Roosevelt signed the Banking Act of 1933, a part of which established the FDIC. At Roosevelt’s immediate right and left were Sen. Carter Glass of Virginia and Rep. Henry Steagall of Alabama, the two most prominent figures in the bill’s development.

The Glass-Steagall Act of 1933 was passed after the Great Depression to prevent THIS very scenario — commercial banks taking too much risk with depositors’ money — from happening again. This act separated the activities of the commercial banks from those of the riskier investment banks.

And for 66 years it worked!

But, after years of lobbying by powerful Wall Street bankers, the Glass-Steagall Act was repealed in 1999, allowing commercial banks to once again engage in risky investment banking activities.

The result: Nine years later we paid the price.

Maybe the solution to prevent further systemic risks to the country’s financial system is not to introduce the complicated policies being floated around right now, but to simply reinstate the Glass-Steagall Act of 1933.

Best wishes,

Monty This investment news is brought to you by Money and Markets. Money and Markets is a free daily investment newsletter from Martin D. Weiss and Weiss Research analysts offering the latest investing news and financial insights for the stock market, including tips and advice on investing in gold, energy and oil. Dr. Weiss is a leader in the fields of investing, interest rates, financial safety and economic forecasting. To view archives or subscribe, visit http://www.moneyandmarkets.com.


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