The proposed big bank tax by the administration and Congress is a bad idea because it is punitive, discriminatory and just the wrong tax at the wrong time.
It is politically popular to force big banks to continue to pay for their financial crisis "sins," but why not punish other banks and nonbanks and even the regulators themselves for their roles in the crisis?
Singling out the "too big to fail" banks for such a tax will not only force them to pass along these costs to their customers and possibly reach for riskier assets, but also put them at an international competitive disadvantage. Plus it will only be a matter of time before such a tax creeps toward midsize and smaller banks.
The best way to increase tax revenue and decrease the budget deficit is to grow the economy and increase employment by encouraging banks to lend. Taxing big banks at this critical time in our recovery can have the opposite effect, as the 10 largest bank holding companies control half of all bank deposits.
There is a far better way to deal with TBTF banks. It starts with the realization that nothing the Beltway Bureaucrats can do, including such regulatory opiates as higher capital requirements, living wills, or stress tests, will eliminate TBTF. The failed Lehman experiment by Treasury and the Federal Reserve taught us that when systemically important financial institutions face liquidity or other serious problems they must be immediately bailed out to stabilize the system to buy time for an orderly resolution. Period.
TBTF banks therefore must pay for this privilege through a reformed FDIC deposit insurance system. The current system is far from optimal since the FDIC insurance fund has now twice been insolvent (in 1991-92 and 2009-11). Banks can't go bankrupt twice, so why should their insurer? If the FDIC acted as a true "insurance corporation" it would have been charging market-based premiums to TBTF and other banks that posed special risks.
For example, in addition to regular premiums, special risk premiums for all banks, regardless of size, with a targeted risk profile such as subprime lending, rapid growth, or de novo banks could be assessed a 3-basis-point annual surcharge for each such profile. TBTF banks, in addition to regular premiums, could be charged another 3- to 8-basis-point special assessment based on total assets, depending on their risk profile. The new premiums would be at market rates, based on recent studies of the value of the TBTF subsidy and other actuarial studies of risk exposure.
These market-based TBTF assessments, which would be neither punitive nor discriminatory, would be more bearable to big banks and allow them to do what they do best make loans.
FDIC deposit insurance reform is possible. I proposed it in testimony before the FDIC and Congress in 2000 and 2001. In fact, my April 25, 2000 testimony before the FDIC Roundtable on Deposit Insurance Reform can still be found at http://www.fdic.gov/deposit/insurance/initiative/thomaswharton.pdf.
But these reforms were never seriously considered because the FDIC and Congress were convinced by the banking industry that they were unnecessary. We all know what happened years later. If these TBTF and other risk assessments had been in place in 2001 they likely would have prevented the insurance fund from going into the red a second time.
Now that big banks are facing a serious tax proposal from both Congress and the administration perhaps they will realize that a truly reformed deposit insurance system, where market-based premiums are kept within a stronger FDIC fund instead of paying a tax to Treasury, is the most efficient way to deal with the TBTF issue.
Kenneth H. Thomas, an independent bank consultant and economist, was a lecturer in finance at the University of Pennsylvania's Wharton School for more than 40 years.