FINANCIAL ACTIVITIES TAX
● The FAT consists of a levy on the value added of ALL financial institutions, including insurers, hedge funds, private equity firms and so on.
● It comprises two elements: a tax on profits and a tax on remuneration.
● This could be justified as an alternative to charging VAT. However, the comparison with VAT raises two important issues: firstly, whether or not input VAT would be deductible from the FAT, since financial companies are currently unable to claim relief for input VAT; and secondly, whether or not a normal VAT charge would then be passed on to customers through a higher price.
● The excess profits component of the tax would probably be based on the notion of the ACE – an “allowance for corporate equity”. The idea is that profits are subject to taxation only above the normal return. For debt finance, the normal return is simply the interest payment. For equity finance, it would be a notional return on the provision of equity finance. The tax base would therefore be profit after deducting interest payments and the notional return to equity finance.
● The notional required rate of return depends in principle on the risk of default. In the simple case in which the government guarantees a tax relief based on the notional return, then it becomes risk-free, and the appropriate rate of relief is the risk-free rate.
● An excess profits tax of this form has been proposed as a replacement for a standard corporation tax, to be applied to all companies. It is currently used in Belgium. However, the FAT appears to be intended to be levied on top of a normal corporation tax.
● The FAT has an advantage over a pure excess profits tax alone in that the base is very much larger. This means that a lower rate can be levied to raise a given amount of revenue. It also implies that paying out gross profits in the form of bonuses would not affect the overall tax liability. The tax is therefore neutral with respect to bonus payments.
● A pure excess profits tax should, however, be completely neutral in its effects. By contrast, a tax on total value added would not be neutral, and may be passed on to consumers in higher prices.
● However, because the tax is based only on excess profits and total remuneration, then it should not directly affect the ways in which banks either raise finance, or invest. Even in the presence of the FSC, discussed below, regulation would therefore continue to be required to control systemic risk.
FINANCIAL STABILITY CONTRIBUTION
● The FSC would comprise a levy on all financial companies, designed to pay for the fiscal cost of any future government support to the sector in the event of another financial crisis.
● The monies raised could either accumulate in a “resolution fund” to cover the expected cost of winding down failed institutions or they could feed into general revenues.
● The levy rate would initially be flat but would be refined over time to reflect risk. The charge is intended to be similar to an insurance premium: riskier companies – in terms of both the risk they take on and their contributions to systemic risk in terms of size, interconnectedness and substitutability – should pay more tax.
● The measure of risk proposed is the proportion of the company’s assets funded by uninsured liabilities.
● The IMF has suggested that, based on past experience, many countries should provisionally aim to raise around two to four per cent of GDP.
● The US has proposed a similar tax based on uninsured borrowing by banks. Sweden introduced a “stability levy” in 2009 of 0.036 per cent of bank liabilities, excluding equity capital and junior debt. ● The aim of the IMF proposal is to raise revenue to offset the cost of financial bailouts, rather than to affect bank behaviour. But by raising the cost of borrowing, both taxes should tend to encourage banks to use more equity capital.
● Excessively small equity capital is an important factor in determining the financial fragility of a bank. A tax on the main alternative form of finance therefore seems consistent with encouraging banks to use more equity capital.
Source: IMF; we are grateful to the Oxford University Centre for Business Taxation for its help