Tuesday, June 29, 2010

Taxation by Regulatory Discretion

What is most startling about the Financial "Reform" package before Congress is how vague it is and how much regulative power and tax power is simply left to the discretion of government agencies. Talk about the creation of power centers, that's really what the "reform" bill should be called, "The Power Center Creation Act". John Carney emails (My emphasis) :

A bank tax of nearly $20 billion was attached to the Dodd-Frank financial regulation reform bill in the final, late night hours of negotiation. When Senator Scott Brown (R-Mass) discovered the tax at the end of the huge bill, he explained that he may have to change his vote to oppose the bill. He's pledged to oppose any new taxes and fears the bill for the tax will be passed on to bank customers.

But the worst part of the bank tax--officially known as the "Financial Crisis Special Assessment"--probably is not the fact that it could result in higher bank fees. It's the fact that the tax is extremely vague and its application is largely left to regulators. This means that financial companies--from hedge funds to community banks to huge Wall Street firms--have no idea what the bill for the tax will be. That uncertainty will roil bank stocks and financial markets, as analysts and investors try to guess how this tax will impact bank earnings.

The regulators are told that they must assess around $19 billion from financial companies, but given wide discretion about how much to charge any individual company. The law instructs regulators to consider 13 factors. Some are entirely sensible: the size of the balance sheet, the reliance on short term funding, and the nature of the assets and liabilities of the firm. Others are a perplexing, including directives to consider whether a company is an important source of credit for low-income and minority communities and the role of a company in supply muni credit. Does lending to low-income communities count for or against a bank? The law doesn't say.

This opens the possibility for the further bureaucratic control of bank lending, with banks pressured to lend according to political priorities rather than credit-worthiness. This is a recipe for economic distortion and increased risk in the financial system.

Meanwhile, banks cannot know how their businesses will be taxed and what asset mix will trigger higher taxes. This uncertainty may lead to paralysis and contracted credit until the regulators make clear how the tax will be applied.

Brown's opposition may kill the tax. But the very fact that lawmakers inserted it into the bill without any public debate indicates how heedless Capitol Hill's chiefs are about the unintended consequences of the financial reforms they are putting in place.
John's full report on the tax is at CNBC.

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