Obama To Tax Leverage

There's been much talk this week about the Obama administration's desire to obtain $120 billion from the banks with a new tax, especially for them. The President is expected to explain that tax tomorrow, but the Wall Street Journal managed to get a leak ahead of time. From what it's learned, the tax appears to be on big banks' net liabilities. In other words, the more a bank's liabilities outweigh its assets, the more it will owe. Put one more way, the more highly leveraged a bank, the more it will have to pay. It's effectively an excise tax on leverage.

Here's the WSJ's description of the calculation:

The government would likely calculate liabilities by subtracting the total of a bank's equity and insured deposits from its assets

So, in a sense, the less capital that a bank has to back up its bets, the more it will owe Uncle Sam. It taxes unprotected risk. From a historical perspective, a tax like this isn't shocking. Taxing behaviors that the government deems unsavory is one of its favorite pastimes. Just ask smokers how much they pay for their cigarettes.

If the administration wishes to create this tax as a sort of regulatory check on risk, then that would sort of makes sense (see the next paragraph). But that doesn't appear to be what it's doing here. According to what I've read, the tax would only exist for a few years, until the $120 billion mark has been reached. Then it will disappear. Maybe I'm missing something, but I'm not sure how a temporary tax on big banks' risks to pay for costs resulting from mortgage modifications and the bailouts to the auto companies and AIG makes sense on really any level.

But what about as a permanent regulatory measure? There's certainly an argument for a framework like this. The tax revenues could sit in a sort of "just in case" fund, to be used in times of financial emergencies. Then, if another financial crisis hits, any costs borne by the government in cleaning up the mess could be covered by the fund.

I still think it's a silly idea, however. If you're want banks to have less leverage, then just create leverage limits. Isn't that a simpler, cleaner approach than trying to determine a tax rate to pay for the cost of impending doom if highly leveraged banks fail? Why should we want a financial system where banks can take unlimited risks, as long as they're okay with paying the associated tax for doing so? I'd prefer stability, and a more direct approach.