It is fun and politically profitable to attack banks and bankers, especially in the wake of a bailout program estimated to have cost American taxpayers some $150 billion. Given this, the plan floated yesterday by the Obama Administration to charge a “fee” (read tax) on financial institutions to cover losses under the TARP program is understandable. That doesn’t make it sensible.
The plan will do nothing to force those responsible for much of TARP’s losses — primarily AIG, General Motors, and Chrysler – to reimburse the Treasury one cent. That money is likely lost. It will, however, force firms that didn’t take bailout money – and those that took money but have already paid it back with interest, to subsidize the money losers.
Worse, it promises to do so in a way that is going to make the financial system less sound, and possibly even make it harder for ordinary Americans to save for retirement.
As reported so far, there’s no word on exactly what form the fee would take, but several potential methods have been mentioned, each worse than the next one.
• Surtax: It could be a surtax on top of existing business taxes, to be paid by firms over a certain size. But this would hit the healthiest firms – those least likely to impose bailout costs. Of course, the mere existence of such a surtax will immediately reduce the stock price of financials that still need to raise capital levels, and are vulnerable to further losses on commercial real estate, consumer products, etc.
• Excise tax: Under an excise tax, assessed on assets, payroll, or perhaps average pay of top executives, firms would be taxed more “equally”. But that means problem institutions will be further weakened and be even more vulnerable to failing. Moreover, excise taxes no doubt will be used to penalize politically unpopular expenses – regardless of justification — increasing government micromanagement.
• Surcharge on financial transactions: A third proposal would be to charge a 0.25 percent tax on all stock, bond or other financial transactions. Unfortunately, this idea would mainly hit the 401(k) type retirement savings accounts of ordinary Americans, for a very high proportion of stock transactions are connected with the management of these accounts. The tax, small as it seems, will be added to the costs paid by these plans, thus further reducing the money that future retirees will have to live on.
This is completely the wrong approach to reducing the swollen deficit, and will inevitably cause more problems than it solves. It is a bad idea being used to score political points, and should be dropped.
Not only do government wage controls not work, they usually backfire. Perhaps worse, like a lot of ill-conceived government schemes, they often punish the wrong people. The Federal Reserve yesterday announced a bank pay limits affecting every bank employee in America in (over)reaction to controversy to big bonuses at a few big banks and insurance companies.
On the backfire “front,” the government has tried three times in recent decades to limit executive pay:
- First, in the 1980s Congress limited “Golden Parachutes” because of public outrage at a few outrageous examples of executives at merged firms getting outsized payoffs. The result of the regulation, however, was to legitimize the once-rare practice until 70% or more of CEOs had such agreements.
- Second, in 1993 the Clinton Administration capped tax deductions for compensation at $1 million, and effectively insisted that compensation above that amount be paid in stock or options. As a result, when the stock market boomed in the 1990s and again through most of this decade, executive pay skyrocketed.
- Third, the Securities and Exchange Commission in 1992 required companies to compare executive pay to “peer” corporations. Since everyone thinks they are above average, executive pay rose, especially for the lower half of executives. (Many observers call it the “Lake Wobegon Effect”: all the executives are above average).
There is no excusing Wall Street Executives who took shockingly huge paychecks while driving their companies into the ground. The problem is that government pay controls can’t fix the problems, and they often make it worse. The culprits in the current pay controversy are top executives at a few large banks and insurance companies bailed out by the government. Frankly, those executives are not entitled to any pay at all: the alternative to the government bail-out was bankruptcy, and the executives likely would have lost their jobs and their fancy pay packages. Most of those folks now have salaries controlled by the government Pay Czar.
The problem is that stringent pay caps won’t work either: executives simply leave the firms, which are now having trouble hiring qualified replacements. This is one more reason why the bail outs were a bad idea.
Even worse, the Federal Reserve Board has now issued a pay policy that effectively punishes lower-level employees at every bank in America for the excesses of Wall Street execs. As the Wall Street Journal puts it, small town bankers are having to pay for the sins of the big banks. This too, is unfortunately typical of the government: over-reacting to a controversy with an overbroad, one-size-fits-all mandate.
It is no excuse for the big bankers’ pay grabs, but the government fix won’t work, and it punishes the wrong people. The government rules will hurt the whole banking sector, and they still won’t stop unscrupulous executives from taking outsized pay by skirting whatever rules the government devises.