Fee to be based on liabilities The fee would be 15 bps based on the “covered liabilities”, which are assets minus Tier 1 capital, FDIC-insured deposits and insurance liabilities covered by state regulated funds. The logic is that Tier 2 and Tier 3 liabilities serve as a proxy for risk trading activity and that firms engaged in such activities should bear additional costs.

Support The proposal will strike a positive tone from a populist perspective and be politically popular. The Democratic leadership in the House has indicated support for the proposal and it’s too early to speculate where the Senate might stand.

In details The fee would go into effect on June 30 2010 and would last for 10 years. The fee collected would contribute to the overall reduction of the budget deficit. I believe that is the bottom line, the Administration will need to decrease the horrifying budget deficit by increasing taxes to someone, and financial institutions look like the perfect candidate.

Flaws and uncertainties About 50 institutions could be subject to the new tax, including US subsidiaries of foreign firms. The Administration has not yet decided if off-balance sheet liabilities would be eligible to be taxed. So here is what needs to be clarified: If the tax is on only domestic liabilities, then a financial institution could avoid the tax by allocating the liabilities to its foreign subsidiaries or to a foreign SPV (Special Purpose Vehicle).  An SPV is an off-balance-sheet liability that is usually created by the parent company for the purpose of selling asset backed securities and securitization purposes. If the tax is on consolidated liabilities, then the Administration has no authority to tax the consolidated liabilities of foreign institutions operating within the US, which means that foreign institutions can avoid the tax while their US competitors cannot. 

The reality While the behavior of many major financial institutions or their leaders was unjustifiable, the proposed tax is both designed incorrectly, irrelevant and it makes little economic sense.  Moreover, the spin that the tax is intended to recoup the losses banks caused to the TARP is misleading, because the primary sources of those losses to date have been Freddie and Fannie and the automobile companies that are exempted from the tax. There is no justification from the taxpayers’ perspective of excluding them from responsibilities for losses, as well. I guess it would make little sense for the Administration to tax itself. Finally, it should be noted that government support to financial institutions extends far beyond just the TARP. Subsidies have come in the form of access to low-cost funds, through borrowing at subsidized rates utilizing Federal Reserve special programs, from merger assistance, from FDIC deposit and debt guarantees, and from the implicit subsidy inherent in too-big-to fail.