Taxing Banks Fairly Workshop

Wednesday 2 October 2013

University of Birmingham (UK)

The interdisciplinary AHRC ‘FinCris’ project (www.fincris.net) has a work stream entitled: ‘Taxing Banks Fairly’, which is considering the relationship between regulatory ‘taxes’ on risk taking (risk related capital adequacy, and perhaps also deposit insurance premiums, and liquidity and funding risk requirements) and revenue raising taxes (special levies, perhaps related to systemic importance or size or leverage, to compensate taxpayers for  underwriting  ‘too big to fail’ banks, stamp duties and financial transaction tax (FTT), financial activity tax (FAT), value added tax (VAT), capital gains tax (CGT), income and corporation taxes etc) and their efficiency. While several policy measures, including taxes, levies and regulatory initiatives, are already in place, and a number are still under consideration, the question of how to protect taxpayers from future bank ‘bail outs’ is yet to be resolved satisfactorily and there is a strong possibility that the various regulatory and other taxes will result in double taxation of banks and banking risks; which would be inefficient. Further, the accumulated negative impact of these various taxes on the economic growth is contentious and is a source of concern amongst politicians, academics, and international bodies.

Prevailing business tax rules favour debt over equity financing because of the tax deductibility, or business ‘expensing’, of interest on debt, in contrast to the non-deductible costs of servicing equity finance (dividends etc.); which are arguably double taxed because income and profits generated by the underlying investments are also taxed. In order to achieve a fairer treatment of debt and equity, tax expensing should perhaps be removed to give debt equal treatment with equity, at least for banks, at the fulcrum of leveraging; or alternatively an allowance could be made for equity by allowing a deduction for the return on equity (RoE). However, an increased emphasis on core equity will disadvantage small, and especially mutual, saving banks, because they cannot issue equity, and small and medium sized enterprises; which rely heavily on debt, rather than equity, for external financing.

The European Commission is proposing to introduce a FTT and the UK has a long established stamp duty on the sale of shares and property. However, the ‘Mirrlees Review’ of the UK tax system and the ‘Henry Review’ of the Australian tax system both counselled against transactions taxes because they are economically inefficient, and instead advocate VAT (GST). Currently, financial services in the EU are exempted from VAT and consequently banks cannot reclaim input tax paid on their purchases. This puts banks at a disadvantage and might tempt them to take excessive risk in search of profits. Whilst VAT (GST) is more efficient, it is operationally more difficult to collect, but New Zealand has demonstrated that the obstacles are not insurmountable. The removal of VAT exemption would impose a burden on the final consumers of financial products and services, but it might reduce wasteful use of financial services and eliminate ‘free banking’ in the UK; which is based on inefficient cross subsidisation.

Please submit papers with a title page containing full contact details and names, job titles and affiliations of the corresponding/presenting authors (and names and affiliations of co-authors)  and, on a separate page, an Abstract along with key words  by 1^st September 2013 to Gabrielle Kelly (c.g.kelly@bham.ac.uk)

The format of the conference is designed to allow for as much interaction as possible between the experts from the field. Presentations will be short (around 20 minutes), allowing ample time for discussion. The workshop will conclude with the annual Maxwell Fry Global Finance Lecture (17.15 to 18.45) delivered by Professor CHARLES W. CALOMIRIS, who is Henry Kaufman Professor of Financial Institutions at the Columbia University Graduate School of Business and a Professor at Columbia’s School of International and Public Affairs, entitled: “The Political Economy of Inflation-Tax Banking: Brazil and Mexico in the 19th and 20th Centuries”

For further details, please contact Sajid Mukhtar Chaudhry (S.M.Chaudhry@bham.ac.uk)

We look forward to seeing you in the Business School, University House, on Wednesday 2nd October 2013.

Conference Organisers: Andy Mullineux, FinCris Co-investigator, Bournemouth University and Sajid Mukhtar Chaudhry, FinCris Research Fellow, University of Birmingham

Attendees:
Appleyard, Lindsey – Fincris Research Fellow, University of Birmingham
Chaudhry, Sajid – Co-organiser and Fincris Research Fellow, University of Birmingham
De Cogan, Dominic – University of Birmingham
Dempsey, James – Fincris Research Fellow, University of Warwick
Dilly, Lucy – University of Birmingham
Fender, John – University of Birmingham
Hayes, Barbara – The Ecumenical Council for Corporate Responsibility, West Midlands
Jackson, Simon – HM Treasury
Kell, Chris – HSBC Holdings Plc.
Lauretta, Eliana – University of Birmingham
Mirza, Afrasiab – University of Birmingham
Mullineux, Andy – Organiser and Fincris Co-Investigator, University of Birmingham
Pradie, Augustin – Ernst & Young, Paris
Price, Norman – University of Birmingham
Rowlingson, Karen – Fincris Co-Investigator, University of Birmingham
Smith, Nicholas – British Bankers’ Association
Sorell, Tom – Fincris Principal Co-Investigator, University of Warwick
Spinassou, Kevin – University of Limoges
Thewlis, Sam – University of Birmingham
Yan, Meilin – Loughborough University

Overview

The purpose of the workshop was to seek views on the appropriateness of bank taxation in the light of the financial crisis and their relationship with regulatory taxes (capital and liquidity) on risk taking. A number of different themes emerged: Financial Transaction Tax (FTT) is an easy way of enhancing revenue that might be used for resolution in case of crisis and to fund supervision, but it distorts markets and is economically inefficient; removal of exemption of Value Added Tax (VAT) for financial services is desirable yet it is sustained by inertia and opportunism; an easier alternative to VAT is Financial Activities Tax (FAT), which is a tax on profits and remuneration of financial institutions; bank levies are a good way to ensure financial stability and they also help offset the debt bias relative to equity financing.

Session Summary

1. Adam Peacock – The implications of removing the financial services exemption from Value Added Tax

Adam Peacock highlighted that there is a common misconception that banks, being VAT exempt, do not pay VAT. VAT exemption means that banks do not charge VAT on products and services they sell and thus cannot recover VAT paid on their own costs. VAT is a tax on consumption, collected on the value added at each stage in the supply chain. VAT exemption for banks distorts pricing, competition and markets and leads to numerous VAT avoidance schemes seeking to reduce their irrecoverable VAT cost. Many of the alleged operational difficulties with removal of VAT exemption for the financial services no longer apply. Systems are more sophisticated and can record transactions at every stage and apply VAT e.g., for interest margin based services, the interest rate spread can be used. Adam concluded his presentation with a proposal of application of flat rate of VAT, like the one that exists in New Zealand. The basis of its calculation can be cash flow taxation. However, this approach is burdensome and costly for smaller firms, as they have to calculate, pay and keep track of taxes and tax credits in different periods. He also suggested a zero Business to Business (B2B) VAT tax and the possible retention of exemption only for supplies or ‘basic’ products and services to consumers. Finally, he argued for an option-to-tax, which is already being utilized in Germany (also there exists an option to tax land and/or building in the UK)[1] where firms are allowed to opt into taxation on certain exempt insurance and financial services.

2. Ian Young – How should banks be taxed in the UK?

Ian Young described the four tenets of a better tax system: fair, simple, certain and competitive. With a view to collecting the tax, Ian drew on ‘transfer pricing’[2] and argued that 50% of the trade is done by groups of companies and they can control the profit in a way they want. He pointed out that the financial sector contributed over 20% of corporate tax revenue in the decade to 2008-2009 and this is double the size of the financial sector in national output. In 2009, the financial sector represented 10% of ‘gross value added’ (GVA). [3] Ian was of the view that financial sector is already contributing a lot of tax revenue and money should not be disproportionately taken out of this sector and taxation should be used only for the betterment of it. He gave a broader overview of different financial taxes, arguing that in order to resolve global solidarity dilemma, the best tax is global currency transaction tax, a targeted FTT. Other taxes like FAT, VAT and a general FTT have many merits yet their broader implementation to avoid misallocation of resources may lead to market distortion, (especially FTT), may lead to relocation avoidance and difficulties for central collection.

3. Arthur Kerrigan – Exemption of financial services in the EU VAT system – what are the options for change?

Arthur Kerrigan argued that it is technically possible to devise a methodology to implement VAT on margin-based financial (e.g., bank loans funded by deposits) services and there is no technical difficulty for fee based transaction, in a fair manner by striking a balance between simplicity and details. However, the current situation is sustained by inertia and opportunism because of the operational difficulties linked with removal of exemption of VAT, and what is missing is an economic debate on the cost of these. He argued that exemptions are granted in the public interest; however, EU VAT exemptions are the biggest single source of disputes and litigation, and financial services exemption accounts for most of these. The most significant tax banks pay is irrecoverable VAT and there is no way of measuring this accurately because of difficulties in getting data. Governments generally do not separate revenue from irrecoverable VAT and there is no required disclosure of irrecoverable VAT by financial institutions. Arthur explained that with the exemption of financial services revenue accrues where service suppliers are located, rather than where the end user of the supply is located, which, sometimes can harm a very small economy. Finally, he explained that because financial institutions set their own prices on their products, the problems associated with VAT on margin transactions are frequently exaggerated.

4. Michael Keen – Bank levies and the Financial Activities Tax (FAT)

Michael Keen argued that debt bias of taxation is a bigger problem than VAT exemption and it can be resolved by Allowance for Equity (ACE), at least for banks. The debt bias is to some extent being offset by taxes on banks (e.g., bank levies in various countries). The burden associated with government interventions to repair the banking system can be compensated with a bank levy and a financial activities tax (FAT). FAT is a tax on wages plus profits of financial institutions—which is their value added.. He explained that taxation is not a good punishment device, because it tends to tax the survivors of the crisis who may not have been responsible for it. The bank tax aims to raise revenue, or correct negative externalities.[4] The externalities can be dealt with by reducing the incentive to take excessive risk, and hence the probability of failure, and the potential need for bailout (or ‘economic rents’) at the taxpayer’s expense. This can be done by using a ‘bank tax’ (possibly nonlinear) on wholesale borrowing by banks’ leverage. Empirical evidence suggests that tax effects are much smaller for large banks; yet small changes in likelihood of large bank failure can potentially have big welfare impacts. Michael supported FAT because—although tithe VAT is in principle preferable—there are significant operational and political difficulties attached with VAT implementation for the financial sector. There are three categories of FAT taxing different kinds of activities. FAT1, for example, is a tax on value added, includes all bankers’ remuneration and define profits as only returns in excess of normal (or ‘economic rents’). Alternatively, FAT2 is a tax on mangers’ bonuses and is a tax on rents to owners and manager, and FAT3 discourages risk-taking by taxing very high returns on equity and very high remuneration.

http://www.birmingham.ac.uk/Documents/college-social-sciences/social-policy/CHASM/briefing-papers/2013/misconceptions-of-the-financial-crisis.pdf

• What is responsible lending and borrowing?
• Lending to people on low incomes: an overview.

A Brief Overview of Securitisation

The traditional role of banks is to act as intermediaries between savers and borrowers. By taking deposits from savers and making loans to borrowers, banks provide a number of services. They perform a liquidity transformation by taking in short term deposits and providing long term loans; they distribute the risks associated with defaults across many savers; and they minimise the costs of assessing these risks by putting in place repeatable and robust processes for determining the likelihood that any particular borrower will default. While this intermediation has traditionally been performed by banks, it can be performed in other ways, one of which is through the process of ‘securitisation’.

Securitisation is a process that is facilitated by banks or other financial institutions, but differs from standard bank activity since the institution does not stand as a permanent intermediary between lenders and borrowers. Instead, the institution issues loans to borrowers, but then passes the income to investors, together with the risk of those loans defaulting. The way this is done is by taking a bundle of loans, for example a bundle of domestic mortgages, aggregating the value of those mortgages and the revenue streams they generate, and then dividing that aggregate up into packages, each with a value and revenue stream which is a proportion of the whole. These packages are securities, backed by the assets, i.e. loans – or ‘asset backed securities’. If some of the loans that support the securities default, then the securities decrease in value.

To bundle loans together and sell them on, a bank will typically set up a new company called a ‘structured investment vehicle’ (SIV) and sell the loans to that company. The SIV will then hold the assets, create the securities, and sell them to further investors. Sometimes, a single pool of loans will be used to generate a range of different securities. Put simply, the securities will be divided into different groups or ‘tranches’ with different ‘seniorities’ or order of priority of receiving income. When losses occur in the asset pool, it is the more junior tranches that take the hit. It is only once the capital in the junior tranches is exhausted that defaults affect the senior tranches. This is known as ‘structured finance’. For an overview of securitisation and the securitisation market from the OECD, see this report from 2011.

Securitisation and the Financial Crisis

The rise of securitisation as a method of financial intermediation has been a focus for narrative accounts of the financial crisis. In the run up to the crisis default rates on sub-prime mortgages in the US – home loans made to people with low credit worthiness – increased significantly. Importantly, default rates increased to greater levels than expected by the models that had been used to rate securities secured on such loans. Many of the senior tranches of securities had been awarded triple-A credit ratings, but even they started to take losses. Investors became worried that they had no way of reliably pricing securities backed by assets of this kind, and so stopped buying them altogether. It was this that provided a trigger for the financial crisis. That this set of events, that seemed relatively insignificant in the context of the international financial system, could precipitate such a large-scale crisis was blamed in large part on the process of securitisation. In particular, the following features of the process were highlighted:

Product complexity: the securitisation process involves a number of different functions, often performed by different parties – the SIV, a loan originator, an arranger who structures the securities, a servicer who collects payment, an asset manager, trustees who oversee cash distributions and manage compliance, and financial guarantors, i.e. insurers [1] – making it very hard for the final investor to identify and assess the quality of the loans in the asset pool that supports their securities. This problem was exacerbated by the fact that many products were highly complex, combining many different asset types – e.g. mortgages and other kinds of loan – in complex structures that made it hard to predict the securities’ performance based on the performance of those assets. When sub-prime defaults increased, investors lost confidence in mortgage- backed securities generally (even though sub-prime was only a small proportion of the securitisation market), since they were unclear which securities were exposed to these loans, and in what ways.

In-built leverage: the loss of investor confidence was exacerbated by the fact that many securities had ‘leverage’ built in – they were structured so that their value would change more than proportionally to any change in the value of underlying assets. ‘Tranching’ is one way of creating leverage, since the junior tranches pay higher returns than the underlying loan pool, but also take the first losses. Sometimes leverage was increased even further by creating ‘double leveraged’ products. In such cases a pool of junior securities was brought together, and the returns from these used to create a further set of tranches. The junior securities produced by this operation had their returns even further enhanced, but were highly sensitive to any losses in the original pool of loans. Securities were designed in this way to increase the returns they generated, but it also meant that they were more risky. When losses on sub-prime loans increased, potential losses on some securities associated with them were even higher, adding to investor fear.

Bad incentives: the risk which prompted the collapse of investor confidence in asset backed securities was the risk that default rates on assets would be greater than predicted, together with uncertainty as to how great losses would be and where they would fall. Despite the fact that default risk was so important, the institutions involved in the chain that created the securities had little incentive to assess this risk accurately. This was because all the risk was being passed on to the end investors who were buying the securities. In fact, when the market was at its peak, there was a strong incentive to originate and securitise any old loans, so great was the demand. The securitisation process naturally generated these bad incentives.

Liquidity risk: when banks and other financial institutions assessed the riskiness of their securitisation activities they focused on the credit default risk, and they were (in most cases) passing this on to investors. However, another risk existed, and this was the risk that liquidity in the market would dry up; in other words, that investors would stop buying asset backed securities, or stop making loans to support SIVs who had bought them on credit, so that the market would stop functioning, preventing those holding such securities from selling them. This risk materialised when investors lost confidence in the wake of increasing sub-prime defaults. The lack of liquidity effectively precipitated the crisis since the SIVs holding the assets relied on there being a liquid market for their survival. The securities SIVs issued were typically short term, while the assets they held were long term, so in order to maintain funding for those assets securities had to be reissued regularly. When liquidity dried up, it was no longer possible for this reissuing to take place, and the SIVs could not generate the capital they needed.

Connectedness: the fact that SIVs suffered a capital crisis had a knock-on effect throughout the banking system. In particular, in order for the securities they issued to achieve high credit ratings, many of the SIVs had explicit or implicit credit lines with the banks that created them. As these credit lines were short term, the banks were not obliged by law to hold capital against them. However, the SIVs now called on these credit lines, and banks suddenly found that they were facing a capital crisis. To protect themselves, banks started hoarding capital, a move which caused inter-bank lending markets to seize up, exacerbating the problem. This was the ‘credit-crunch’ which precipitated the crisis.

The Demonisation of Securitisation

The outline of the role of securitisation in bringing about the financial crisis is, of course, only a small part of the picture. Securities and securitisation can be invoked in other ways, and other unrelated factors also played a part. Nonetheless, the picture presented is sufficient to show why the process of securitisation has been singled out as a dangerous innovation that should be strictly controlled. However, the narrative that puts securitisation at the heart of the financial crisis risks lumping together features of the process – and the risks and benefits associated with it – with the particular way in which securitisation was employed in the run up to the crisis. Below we outline a number of misconceptions that are encouraged by this narrative.

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[1] Bank for International Settlements. (2005, January). The role of ratings in structure finance: issues and implications.

The primary challenge is that in the wake of the financial crisis many narratives have been developed to explain what happened and why. In part this variety reflects disagreement over the causes of the crisis and how we should evaluate these causes. So, for example, one account may emphasise the role of hedge funds and hold such funds and those that run them accountable for the crisis. Another account may assert that hedge funds played only a peripheral role.

More commonly, however, these different causal chains are consistent with one another, but   each illuminates a different aspect of the events that resulted in the crisis. Each of these attempts to develop a narrative of the financial crisis will therefore invariably present only a partial picture. It may present a causal chain that focuses on global macroeconomic forces and the actions of international institutions, for example. Or it may focus on the actions of a powerful financial elite operating in the US and UK, and their ability to capture regulators. To do justice to any one of these perspectives, however, partial as they are, would require a very large study.

For this reason, we will not try to construct a comprehensive narrative of the crisis. Rather,   we will highlight particularly prominent claims that are common to many accounts of the crisis, and provide a more nuanced perspective on these claims. In particular, we will highlight simplifications or popular misconceptions which materially affect how we might hold individuals and institutions responsible for the crisis.

Below are links to each post in this series, and these will be added to as each is published:

• Securitisation and Its Role in the Crisis

The idea of the paper is to highlight the drawbacks of regulations, as their focus is micro prudential and to provide a private buffer for the idiosyncratic risk of banks as compared to the taxation, whose focus is macro prudential and to provide a public buffer for the systemic risk of banks, a factor that has been broadly ignored in the run-up toward financial crisis. We will substantiate this by providing extensive literature review on the topic.

We regard bank regulation, such as deposit insurance and liquidity requirements, as a non-revenue raising tax on risk taking that should be used to discourage excessive risk taking.

Current tax rules encourage excessive debt because of the tax deductibility of interest on debt. This tax deductibility needs to be removed to give debt equal treatment with equity, which will decrease the leverage of banks. Here, some consideration should be given to smaller banks, as it is difficult for them to raise equity. Furthermore, we are reviewing capital gains tax and corporate taxes to reduce distortions. The aim is to eliminate the taxpayer subsidy of big banks (“too big to fail” banks enjoy an implicit bailout guarantee from tax payers) and level the playing field so they cannot raise funds more cheaply than smaller potential competitors. In sum, the emphasis is on fairness and consistent and equal treatment throughout, which requires differential taxation of implicitly subsidised banks and to remove bias to over use of financial services and debt.

The taxation of stock options and other performance-based remuneration incentivizes managers to take excessive risk in the short term. This needs to be changed and should be aligned with long-term interests of banks. One idea is to increase the “debt” component of banker’s remuneration. It will probably lead to debt overhang problem.

The European Commission is considering a Financial Transactions Tax (FTT) and is supported by Liikanen Report; the UK also has a stamp duty on the sale of shares and property. However, the ‘Mirrlees Review’ of the UK tax system and the recent ‘Henry review’ of the Australian tax system both counselled against transactions taxes because they are economically inefficient, and instead advocate VAT (GST). Currently, financial services are exempted from VAT, meaning that banks cannot reclaim input tax paid on their purchases. This put banks into disadvantage and might lead them to take excessive risk in search of profits. We, therefore, are also of the view that VAT (GST) is economically more efficient, although operationally difficult, and financial services should no more be exempted from VAT. With the Removal of exemption of VAT, the burden has to be borne by the final consumers but it might reduce the unnecessary use of financial services by them, thereby, reducing the negative externalities arising from excessive use. However, we are reviewing these documents to come up with a solid solution before we submit to FEBS conference.

We shall finally compare and contrast practices in different countries (especially New Zealand, Australia, South Africa that seem to apply GST on financial services).

This workstream explores issues relating to bank taxation and regulation. There are two predominant ways of taxing banks with the goal of improving financial stability by discouraging risky activities. One is in the form of prudential regulations imposed by the authorities (‘regulatory taxes’) and the other is through revenue raising ‘fiscal’ taxes. Prudential regulations such as capital and liquidity requirements have traditionally been the dominant means of trying to ensure banking stability. It tends to be bank specific and to provide for a private buffer or insurance of the risks of individual banks. Fiscal taxation is wider in scope, can provide for public, pooled, insurance of the risks to the banking system as a whole; which was largely ignored in a run-up to the recent financial crisis. We aim to focus on the design of a bank regulatory and fiscal taxation regime that will contain the risk of a recurrence of a major financial crisis to an acceptable (above zero) level, given that there appears to be a trade off between financial stability and growth.

Financial stability is a true ‘Public Good’ in the economic sense that enjoyment of it by one person does not reduce the ability of others to enjoy it, and many or most benefit from it.  The taxpayer should thus be willing to share the costs (with shareholders and other fund providers of banks, including depositors) of providing it.  The question is: how much implicit insurance of big banks the taxpayer can reasonably be expected to provide, and how much bank shareholders and customers should be expected to contribute in order to reduce the risk of a crisis to an acceptable level.

If too big or systemically important to be allowed to fail banks are permitted to continue to exist, they will be implicitly insured by tax payers and able to raise funds more cheaply than smaller banks. This will give them an advantage over potential competitors.

• Should they be required to hold more capital and liquidity reserves than smaller banks (even though they can generally diversify their risk more effectively)?

• Should they instead be taxed more heavily and should the tax be on profits or bonuses, or related to their funding gap (between assets and retail deposits), or in some other way?
• Should their products and services be subject to a Value Added Tax (VAT) or a Financial Transaction Tax (FTT)?

The appropriate mix of regulatory taxes (e.g. capital and liquidity requirements) and fiscal taxes also needs to be carefully considered to avoid double or over taxation.  Wholesale deposit funding by banks attracts a higher Bank Levy in the UK, but will also lead to higher liquid reserve requirements under incoming prudential regulations, and it should also be recognised that deposit insurance schemes provide means for pooled risk-related insurance funded by banks.

Theories and Methods

Special bank/financial taxes initiated and proposed in various countries will be reviewed, as will the chances for an internationally agreed tax regime. The IMF produced a report on special bank taxes for the Financial Stability Board in 2010 and dialogue with its authors and other experts will be sought using a workshop scheduled for 27 March 2013 (see below).

Current tax rules encourage excessive debt because of the tax deductibility or ‘expensing’ of interest on debt, in contrast to the non deductable the costs of servicing equity finance linked to, arguably already ‘double taxed’ dividend payments. Tax expensing should perhaps be removed to give debt equal treatment with equity, at least for banks. Furthermore, we will review capital gains tax and corporate tax reforms necessary to reduce distortions. The emphasis is on fairness and consistency of treatment throughout. This may well require differential taxation of banks that are implicitly subsidised by taxpayers and any bias towards over using of financial services and debt to be removed.

The Parliamentary Commission on Banking Standards has been appointed by both Houses of Parliament to consider and report on professional standards and culture of the UK banking sector in order to learn lessons about corporate governance, transparency and conflicts of interest, and their implications for regulation and for Government policy. The Parliamentary Commission on Banking Standards has also appointed a panel to look at tax, audit and accounting. This workstream is listening to the discussions of various experts with a view to gaining insights on taxation.

The European Commission is considering a Financial Transactions Tax (FTT) and is supported by the Liikanen Report; the UK also has a stamp duty on the sale of shares and property. However, the ‘Mirrlees Review’ of the UK tax system and the recent ‘Henry review’ of the Australian tax system both counselled against transactions taxes because they are economically inefficient, and instead advocate VAT (called GST in Australia). Currently, financial services are exempted from VAT, meaning that banks cannot reclaim input tax paid on their purchases. This puts banks at disadvantage and might lead them to take excessive risk in search of profits by engaging in such activities as the miss-selling of Payment Protection Insurance (PPI)  and manipulation of LIBOR.  VAT (GST) is economically more efficient, but operationally difficult to implement. We wish to explore whether or not financial services should cease to be exempted from VAT. With the removal of exemption from VAT, a burden has to be borne by the final consumers, but this more equal treatment might reduce wasteful usage of financial services. We are reviewing documents and comparing and contrasting practices in various countries (especially New Zealand, Australia, and South Africa, which seek to apply VAT/GST to financial services).

Workshops and Meetings

On the 27th March 2013, the tax workstream of the FinCris project will run a workshop in Birmingham on ‘Taxing Banks Fairly’. In this workshop, we wish to seek views on the appropriateness of bank taxation in the light of the financial crisis and particularly the relationship between regulatory taxes on risk taking and revenue raising taxes (special levies, stamp duties and financial transactions taxes, VAT, and CGT, income and corporation taxes) and the appropriateness, especially for banks at the base of leveraging, but perhaps not for SMEs, of the tax expensing of interest on bank debt (and the appropriate treatment of the costs of servicing equity financing).

A subsequent seminar involving tax experts will then be used in October/November 2013 to disseminate our findings.

Work Done So Far

Andy Mullineux has published a paper entitled: ‘Taxing Banks Fairly’ in the ‘International Review of Financial Analysis’, and a working paper ‘Banking for the Public Good’ on the topic. Both papers are available below:

http://dx.doi.org/10.1016/j.irfa.2012.11.001

http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2084149

Andy Mullineux presented his paper entitled “Banking for the Public Good” in 25th Australian Finance & Banking Conference, organised by the Institute of Global Finance and the School of Banking & Finance at the Australian Business School (ABS), UNSW, Sydney, Australia, in December 2012. A link to his presentation can be found here.

Download (PDF, 475KB)

The ethics work stream will employ methods of ethical analysis from philosophy to explore post-crisis obligations of institutions and individuals responsible for the financial crisis; in particular it will link such obligations to the ways in which such institutions and individuals can be held accountable for the crisis and its effects.

The basis for the analysis will consist of the following:

(a)    An agreed narrative or narratives of the financial crisis based on a literature review and interviews with participants in the financial sector, including the most commonly cited ingredients within the banking industry of the crisis, some of the associated regulatory failings, and excesses on the part of non-institutional borrowers, including “sub-prime” borrowers;

(b)   A list of purposes of banks and financial management norms for banks that seem to be agreed by UK policy makers, where failure to pursue those purposes or respect those norms provides prima facie grounds for criticism;

(c)    Ethical arguments for and against these purposes and norms, and a specification of departures from these purposes and norms by banks in (a). Insofar as those departures contributed to   the financial crisis, they will provide grounds for assigning accountability;

(d)   Principles connecting bank accountability with remedies for the costs incurred by governments and taxpayer as the result of the crisis. Some of the principles justifying bank obligations are analogous to “polluter pays” principles; others depend on the fact banks were rescued and what is owed to rescuers;

(e)   A discussion of the way in which, in view of the principles in (d), and the empirical research in the project, the banks and the government might alleviate the plight of the poor through creating or subsidizing financial inclusion institutions;

(f)     Taking into account the regulatory and taxation proposals in the project, ethical arguments for those proposals and ethical evaluation of proposals in UK policy documents.

Theories & Methods

A number of philosophical and quasi-philosophical theories will be exploited for ethical analysis: indirect utilitarianism, especially in relation to purposes of banks; stakeholder theory is relevant to obligations to those affected by “too-big-to-fail” bank operations; stakeholder theory and Friedmanite theory – that the sole corporate responsibility is to increase shareholder value – in relation to the propriety of government bail-outs of commercial enterprises in general and banks in particular; the literature on the Rawlsian “basic structure” in relation to whether banks are among the institutions required for the operation of equal opportunity; liberal justice theory in relation to how disproportionate personal wealth is associated with personal roles in financial institutions, and how the profits of banks and the income of those working for them should accordingly be treated by the taxation system.

Some of the ethical argument will be based on justifiable purposes of banks and accounting norms, as well as a non-trivial norm of intelligibility in financial products and services. Such a norm benefits not only people with low financial literacy, but professional risk analysts and bank regulators: the financial crisis was partly caused by the (even by the standards of financial specialists) esoteric nature of financial products and unadmitted incomprehension of the products and their risks by financial professionals.

The ethics research will also argue from the responsibility principles in (d) above that commercial bank support for financial inclusion of the relatively poor is obligatory, given that one of the effects of the financial crisis has been to shrink the safety net for the relatively poor provided by public spending in the UK and elsewhere.

Initial Conclusions

These different perspectives were amongst those that were brought together in an international philosophers’ workshop held in November 2012 as a first stage to developing the lines of argument set out above. The report of this workshop can be found here: http://fincris.net/philosophers-workshop-report/