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The False Promise of Crisis-Resolution Funds

ROME – Ever since financial markets began to stabilize late last year, the idea of making the financial sector pay for the costs incurred by taxpayers to keep it afloat has gained increasing support among policymakers and the wider public. France and the United Kingdom have introduced a temporary tax on financial-sector bonuses, and the United States government has proposed legislation envisaging a “financial crisis responsibility fee” to recover the costs of America’s Troubled Asset Relief Program. There is also a discussion about how best to reform taxation of the financial sector, which is on average lighter relative to other corporate income and unduly favors borrowing over equity financing.

But a lump-sum charge to recover past costs will not change the financial sector’s incentives concerning excessive risk-taking. Furthermore, it is unclear what, precisely, the costs are that are to be recovered.

While the direct fiscal costs of supporting the financial sector were 2.5-3% of GDP in developed countries (with peaks around 4.5%), the total fiscal impact of the crisis is much larger, amounting to the total expected increase in public debt – an estimated 40% of GDP. And even larger yet is the total cost suffered by the economy – including output and job losses, and the attendant destruction of material and immaterial capital, which, according to the Bank of England’s Andrew Haldane and others, could rise to a multiple of annual GDP.

More recently, the debate has changed tack: taxing the financial sector is now seen as a convenient way to set aside sufficient resources to pay for the next financial crisis. The idea of a tax on the financial sector has become closely associated with that of a crisis-resolution fund. This would pay for the residual costs of a large institution’s failure after its capital has fallen to zero and, presumably, creditors’ claims have been wiped out (though some proposals are ambiguous, leaving room for at least some relief for creditors).