Obama Proposes Financial Crisis Responsibility Fee on Wall Street Firms as House Bill Would Tax Financial Transactions

Financial transaction taxes have been talked about recently as a way of increasing revenue from the financial sector to make it pay for its rescue. In addition, the Obama Administration has proposed a fee on the liabilities of banks and securities broker-dealers that received TARP and other bailout funds. At the same time, Rep. Peter Welch has introduced the Wall Street Bonus Tax Act, HR 4426, that would tax bonuses at financial firms that have received assistance through the TARP program at a rate of 50 percent for all bonus compensation in excess of $50,000, both cash and stock awards. Revenues generated through the tax would fund a new direct lending program administered by the Small Business Administration.

Other legislation introduced in the House, with a companion bill in the Senate, would impose a tax on securities and futures transactions, including derivatives transactions, in an effort to curb speculation and short-term trading. HR 4191, Let Wall Street Pay for the Restoration of Main Street Act, was introduced by Rep. Ed Perlmutter and Rep. Peter DeFazio. Senator Tom Harkin introduced the companion bill, S 2927, Wall Street Fair Share Act.

The Obama plan would assess a Financial Crisis Responsibility Fee on the largest and most highly leveraged Wall Street firms in an effort to recover for taxpayers the extraordinary assistance provided so that the TARP and other bailout programs do not add to the deficit.

The fee, which would take effect on June 30, 2010, would last at least 10 years. If the costs have not been recouped after 10 years, the fee would remain in place until they are paid back in full. In addition, the Treasury Department would report after five years on the effectiveness of the fee as well as its progress in repaying projected TARP losses.

Covered institutions on which the fee would be assessed include firms that were insured depository institutions, bank holding companies, and securities broker-dealers as of January 14, 2010, or that become one of these types of firms after January 14, 2010, and who were recipients and/or indirect beneficiaries of aid provided through the TARP, the Temporary Liquidity Guarantee Program, and other programs that provided emergency assistance to limit the impact of the financial crisis.

The fee would be assessed pursuant to a mandate of the Emergency Economic Stabilization Act, which requires the President to put forward a plan that recoups from the financial industry an amount equal to the shortfall in order to ensure that the TARP does not add to the deficit or national debt.

The fee would be levied on the debts of financial firms with more than $50 billion in consolidated assets, providing a deterrent against excessive leverage for the largest financial firms. By levying a fee on the liabilities of the largest firms , excluding FDIC-assessed deposits and insurance policy reserves, the Financial Crisis Responsibility Fee will place its heaviest burden on the largest firms that have taken on the most debt.

Covered liabilities would be reported by regulators, but the fee would be collected by the IRS and revenues would be contributed to the general fund to reduce the deficit. The Administration will also work with Congress and regulatory agencies in order to design protections against avoidance by covered firms.

Under the House financial transactions tax bill, one half of the revenue generated by the transaction tax would be used to directly reduce the deficit, while the second half of the revenue generated by the tax will be deposited in a Job Creation Reserve Fund. HR 4191 would tax stock transactions at a rate of 0.25%. Futures contracts to buy or sell a specified commodity of standardized quality at a certain date in the future, at a market determined price would be taxed at 0.02%.Similarly, swaps between two firms on certain benefits of one party's financial instrument for those of the other party's financial instrument would be taxed at 0.02%. Credit default swaps where a contract is swapped through a series of payments in exchange for a payoff if a credit instrument, typically a bond or loan, goes into default would be taxed at 0.02%.

In order to ensure that the tax is appropriately targeted to speculators and has no impact on the average investor and pension funds, the tax will be refunded for tax favored retirement accounts, education savings accounts, health savings accounts, mutual funds and, the first $100,000 of transactions annually that are not already exempted.

The European Union is considering a financial transactions tax. UK FSA Chair Adair Turner recently expressed qualified support for a tax on financial transactions, but cautioned against thinking that such a tax could be designed to tune the liquidity of markets to precisely its optimal level, neither too liquid nor insufficiently liquid.

Last March, EU Commissioner for Taxation Laszlo Kovacs said that the Commission did not view a financial transactions tax that favorably since the positive effects of a such a tax have not been clearly documented. The described relationship between liquidity, price fluctuations, and speculation cannot be proven either empirically or theoretically. It is even possible that a tax on financial transactions, and hence on liquidity, could lead to higher volatility.

The tax could also increase the capital costs for companies, noted the Commissioner, as well as increasing the price of urgently needed investments. Also, the relocation of transactions to other markets or countries could result in sustained damage to securities trading in the European financial centers. The effect of the tax could be very different depending on the traded products and the organization of the market.

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