Bank taxation and regulation
Natasha Agarwala, Sajid Mukhtar Chaudhryb and Andrew Mullineuxc
a University of Oxford, Department of Economics, Manor Road Building, Manor Road, Oxford OX1 3UQ, United Kingdom
b Birmingham Business School, The University of Birmingham, Birmingham B15 2TT, United Kingdom
c Business School, Bournemouth University, Bournemouth BH8 8EB, United Kingdom
Abstract
This study gives an overview of bank taxation as an alternative to prudential regulations or non-revenue taxation. We review existing bank taxation with a view to eliminate distortions in the tax system, which have incentivized banks to engage in risky activities in the past. We particularly focus on ‘too big to be allowed to fail’ banks that have been enjoying a competitive advantage over their smaller counterparts. In order to ensure financial stability, we put forward the following arguments (1) a financial transaction tax is economically inefficient and potentially costly for the economy and may not protect taxpayers, (2) a bank levy is perhaps good for financial stability to finance resolution mechanisms but it poses the threat of double taxation together with the proposed Basel III liquidity ratios, (3) a financial activities tax can serve as an alternative to value added tax while leaving the tax distortions of exemption of value added tax as it is. As the stock of non-core liabilities reflects the under-pricing of risk in the financial system; we are of the view that a levy on non-core liabilities may perhaps mitigate the ‘too big to fail’ problem. Furthermore, we support the elimination of exemption of value added tax on financial services to provide banks level playing field, while leaving the payments system out. It is expected to improve the efficiency because it might stop the wasteful use of financial services. To avoid distortions, VAT should be applied to all financial services, including complex ones such as derivatives. VAT might reduce bank lending because of higher costs for customers, but arguably there was over borrowing prior to the financial crisis.
Keywords: banks, taxation, regulation, too big to fail banks
JEL codes: G28, G21, H20
* Corresponding author. EMAIL: s.m.chaudhry@bham.ac.uk