That new IMF report…

I’m liking it.

Matthew Yglesias points me towards the IMF blog [1] which has some more explanation on their Financial Activities Tax.

A FAT is just a tax on the sum of the profits and remuneration paid by financial institutions. That sounds simple, and, in essence, it is. But why an extra tax on financial institutions? Here, I’m afraid, things get a bit nerdy. So brace up for what is coming.

Profits plus all remuneration is value added. So a tax of this kind would be a kind of Value-Added Tax or VAT. And that could make sense because current VATs don’t work well for financial services, which are largely VAT-exempt. This means that a FAT of this kind could make the tax treatment of the financial sector more like that other sectors and so help offset a tendency for the financial sector, purely for tax reasons, to be too large—or too fat.

Now suppose that the base included only remuneration above some high level, and only profits above a ‘normal’ rate of return. Then the base of the FAT may not be a bad proxy for taxes on ‘rents’—return in excess of competitive levels—earned in the sector. Some might find taxing that excess fair.

Or one might include only profits above some level well above normal. Taxing away some of these high returns in good times may help correct for any tendency to excessive risk-taking implied by financial institutions not attaching enough weight to outcomes in bad times (whether because of limited liability, or because they think themselves too big to fail).

A tax on rents? Sounds good to me. It sounds like it would reduce the size of the financial sector too which would be good in a number of ways.

  1. Smaller financial firms would mean a smaller systemic risk of crises.
  2. A less powerful financial lobby twisting the state’s arm.
  3. Finance would stop attracting intelligent people to extract rents who could instead do something productive.
  4. Many crises spring from the financial sector so shrinking it should help diminish the frequency and severity of these.

What happened to the IMF in the last 10 years? It seems like they may have actually learned from some of their mistakes.

[1] Yes, they’re using the theme I used to use for this blog. The IMF, apparently quite frugal.