Fair and Substantial—Taxing the Financial Sector

By Carlo Cottarelli

(Version in 日本語  )

We knew we were in for a tough time when the leaders of the Group of Twenty (G-20) asked the IMF to give them our views, at their summit coming up in June 2010, on  “… the range of options countries have adopted or are considering as to how the financial sector could make a fair and substantial contribution toward paying for any burden associated with government interventions to repair the banking system.”

Everyone has strong feelings these days on the taxation of the financial sector. Taxpayers who financed the rescue of the financial sector during the recent crisis want their money back—or at least not to get caught again. Some want to see more of the money coursing through the financial system turned to public use.

The industry worries about new taxes coming on top of the swathe of regulatory reforms that likely lies ahead for them. And some governments in countries whose financial sector weathered the storm pretty well wonder why they should now ask it for cash. Responding to the request from the G-20 leaders puts us in the middle of all these concerns.

Last week the IMF gave an interim report to the G-20 finance ministers focused on the specific question we were asked: what are the options in raising money from the financial sector to pay for the costs of government intervention from which it benefits. That report is confidential, but—you may have noticed—has still managed to attract a lot of attention.  So let me set out how our thinking on this stands.

Our aim is to take a cool look at the issues about which everyone gets so heated. The options we have come up with so far—this interim report will be revised for the June summit—won’t please everyone (or, maybe, anyone), but can, we hope, help move the public debate ahead by bringing some economic and financial analysis to bear. In doing this we looked forward more than back. Revenge is not a good principle for tax design, but averting and preparing for future harm is.

What is to be done?

The challenge is to ensure that financial institutions bear the direct fiscal costs that any future failures or crises will impose—and maybe somewhat more, given all the other costs that bank failure can impose on the economy.

We also need to make these events both less likely to happen and less costly when they do. We think two types of tax can play a role.

A ‘Financial Stability Contribution’—I come to bury Caesar, not to bail him out

One reason the crisis was such a painful mess was that many governments did not have the tools to wind down failing institutions in a quick and orderly manner. All too often their only options, both hugely unpleasant, were to either (1) let a systemic institution fail and bear the chaotic fallout or (2) pump in enough public support to keep it alive, so confirming the prior suspicion that these institutions were indeed too big to fail. Governments lacked a way to ‘resolve’—a new word even for many economists—large failing institutions.

Resolution means equity holders would be wiped out, management replaced, and unsecured creditors take a loss—a ‘haircut’—on their claims. All this should be nasty enough for owners and managers to reduce any problems of ‘moral hazard’ (taking too much risk in the expectation that someone else will bear the costs if things turn out badly). But most countries still don’t have such a mechanism. Financial stability requires creating them.

So where does the idea of a contribution come in? Resolution requires upfront cash, to reduce uncertainty for creditors (and the creditors’ creditors…) by quickly giving some value to their claims. And the industry should pay for this: it is, or should be, a cost of doing business just like paying for deposit insurance, or maintaining their information systems. This is what we call a Financial Stability Contribution (FSC).

It would ensure that the industry does indeed pay a reasonable chunk of these resolution costs before a crisis occurs, with this amount topped up, if needed, by ‘ex post’ charges after disaster strikes (much as the Financial Crisis Responsibility fee proposed in the United States aims to recoup some of the costs of public support).

Costs of the crisis

Incidentally, as a first step, we tried to figure out how much the recent crisis has cost governments in terms of the direct support they provided to the financial sector. The answer is: so far, about 2.7 percent of GDP for the group of advanced G-20 countries. More for some, less for others – including most emerging market countries.

That’s a sizable sum, but the risks during the crisis were even larger, with guarantees and other contingent liabilities averaging around 25 percent of GDP for the advanced G-20. And all that ignores indirect fiscal costs caused by the recession and (to a lesser extent) stimulus measures—which is causing a surge in public debt—and, perhaps most cruelly, of all, a cumulative loss of output of around 27 percent of GDP.

The FSC would start as a simple levy on some balance sheet (and, possibly, off-balance sheet) variables, but then be refined to strengthen the link with each institution’s contribution to systemic risk—giving them some incentive to reduce it. It would be permanent (to keep that beneficial effect at work, at least until regulatory solutions are felt to have done enough) and paid by all financial institutions (because they all benefit from the greater financial stability the resolution mechanism provides).

Whether the revenue from such a charge should be treated just like other tax revenue or instead feed an earmarked fund to help with resolutions is secondary. The fiscal impact is the same (assuming of course, other policies are not affected by whether there is or not an earmarked fund): the government has to sell fewer bonds on the open market, either because it has more tax revenue or because it has a captive customer in the fund. The main argument for a fund is that it could provide more assurance that the agency in charge of resolution has ready access to the resources it needs.

A ‘Financial Activities Tax’

A FAT is just a tax on the sum of the profits and remuneration paid by financial institutions. That sounds simple, and, in essence, it is. But why an extra tax on financial institutions? Here, I’m afraid, things get a bit nerdy. So brace up for what is coming.

Profits plus all remuneration is value added. So a tax of this kind would be a kind of Value-Added Tax or VAT. And that could make sense because current VATs don’t work well for financial services, which are largely VAT-exempt. This means that a FAT of this kind could make the tax treatment of the financial sector more like that other sectors and so help offset a tendency for the financial sector, purely for tax reasons, to be too large—or too fat.

Now suppose that the base included only remuneration above some high level, and only profits above a ‘normal’ rate of return. Then the base of the FAT may not be a bad proxy for taxes on ‘rents’—return in excess of competitive levels—earned in the sector. Some might find taxing that excess fair.

Or one might include only profits above some level well above normal. Taxing away some of these high returns in good times may help correct for any tendency to excessive risk-taking implied by financial institutions not attaching enough weight to outcomes in bad times (whether because of limited liability, or because they think themselves too big to fail).

What about a financial transactions tax?

We also looked at the idea of a general financial transactions tax (FTT)—the last few months have left us in no doubt as to the seriousness of the public support this enjoys. This would be a tax paid every time a share, bond, or other financial instrument is bought or sold, and/or whenever foreign currency is bought or sold.

Our work is not yet complete—this is an interim report, remember—but, while some forms of FTT may be feasible (indeed most G-20 countries already tax some financial transactions), we don’t think this is the best way of meeting the two key objectives set out above. An FTT is not  focused on reducing systemic risk and it isn’t effective at taxing rents in the financial sector—much of the burden may well fall on ordinary consumers.

Moreover, the financial services industry is very good at devising schemes to get around such a tax and (this is also true, to be fair, of the FSC and FAT, but we suspect to a lesser extent).

One way to think about the comparison is that just as a FAT is like a VAT, an FTT is like a turnover tax—and most countries have long found that the VAT is better at raising revenue: in the jargon, more efficient. All this doesn’t mean we rule out an FTT in other contexts—but it is not the most effective way to address the task at hand.

Should everyone do this?

Several countries that did not need to pour large resources into their financial institutions are naturally reluctant to lumber them with more charges. At the same time, financial institutions are so adept at tax and regulatory arbitrage that those countries who do want to act fear they may be undercut by  those who don’t.

But this tension is not as great as it may seem.

If financial history teaches us anything, it is that no one should think themselves immune from failures and crisis. Moreover, if the FSC in particular is properly risk-adjusted, countries with safer systems will simply face a smaller contribution. And importantly, the last thing we want to do is to repress/bury the financial sector by imposing a heavy burden; like the food supply, it means too many good things for economic growth.


What we gave to G-20 ministers was an interim report, and we will be working more on this in the light of their discussion last Friday.

We will continue too to listen to what others tell us. One theme of our work that has already been widely stressed is that any tax initiatives need to be coordinated with regulatory ones—so we have some number-crunching, as well as more tough times, ahead of us. Still, we hope to contribute to the debate on what really matters in all this: how to reduce the risk, and costliness, of future financial failures.

Carlo Cottarelli is Director of the IMF’s Fiscal Affairs Department.

24 Responses

  1. […] the IMF’s Fiscal Affairs Department, explains some of the thinking behind the proposals at the IMFDirect blog. Share this:TwitterFacebookLike this:LikeBe the first to like this. Published: April 23, 2010 […]

  2. […] La deuxième, qui n’est pas assez connue du grand public, est que le secteur financier est un secteur sous taxé. La TVA actuelle ne s’applique pas au secteur financier qui en est en majorité exempt. Une étude intéressante avait d’ailleurs été réalisée par le FMI sur ce sujet. […]

  3. Current regulations require from banks much less capital when lending to anything officially perceived as not risky, like the AAA rated and the public sector, than when lending to what is officially perceived as more risky, like the small businesses of entrepreneurs.

    Q. What is the tax value implicit in that regulatory favoritism of the public sector? A. Enormous! The problem for the IMF is that since it works for the governments, it is not free to talk about this, much less calculate it!

    A small tax on financial transaction would produce minimal distortions when compared to those produced by the current-regulations, nonetheless, because, as always, these would end up being paid mostly by those who the regulations discriminate against, the small businesses and the entrepreneurs… this would make job creation so much more difficult. Is this what you want?

  4. “The challenge is to ensure that financial institutions bear the direct fiscal costs that any future failures or crises will impose — and maybe somewhat more, given all the other costs that bank failures can impose on the economy”.

    Although we can, and I believe must, criticize legislators, regulators, and central bankers for tortuously slow progress in meeting that challenge, I think we can only be fair to those involved in reaching actionable majorities in innumerable committees if we acknowledge that progress on that “front” has been made. An annual bank levy has been applied in, for example, the UK, where banks are extraordinarily significant in the economy. And the principle of banks being required to write “living wills” to assist their dismemberment should they be in jeopardy of bankruptcy is being implemented firmly in Canada.

    What concerns me today, which is nearly a year after this iMFdirect thread was started, is that although it is a truism that vulnerability to unforeseen catastrophes is “grown” one transaction at a time, stating that truism again can be helpful. Specifically, it helps one recognize that

    o FSCs and FATs (or financial sector VATs) only induce wisdom — or responsibility or prudence, depending on one’s perspective and linguistic habits of word selection and interpretation — slowly; and

    o During this period of potential learning by financial sector actors and their managers, the “brains” who make a living out of externalizing their arbitrages around the regulatory practices by which FSCs and FATs must, shall I say, “be garnered”, can be, and history tells us they usually are, hard at work devising new financial derivative contracts even more complex than the last wiz-bang-wallop variety.

    But FTTs, by contrast with FSCs and VATs, can be devised, depending on their design, to induce much more quickly the wisdom/responsibility/prudence we do want. But the design options by which to accomplish this more desirable learning may not be obvious to some. Therefore a paper that offers as brief a general overview as possible of “smart” FTT design principles is available at the following URL:


    The paper there is all but final after incorporating the inputs of a significant network of people with recognized expertise from BOTH WITHIN AND OUTSIDE the financial sector. It therefore constitutes a summation of a rationale for the IMF to consider in updating its advice, given in its paper of September 2010, to G20 Finance Ministers and country leaders.

    Dissatisfaction with the way the Seoul final communique failed to address the still urgent issues of financial reform has been widespread. So now would be a good time for that IMF paper to be updated.

    There’s a time for all seasons. Not only do we have to keep the long-term goal of better coherence between the financial sector and the non-financial sector in mind. Today, in a period of physical instabilities in the Middle East and Japan, the challenge of sealing off the derivative “aquifer of externalization” that threw the global economy for a loop when AIG could not meet its derivative insurer’s obligations is not primarily a mortgage securitization issue. It’s one in which we can already see the burbling of pricing bubbles in food, energy, and rare metals. These are crucial commodities for our survival and transition to a sustainable and modestly fair economy. So there’s no time to lose.

    • Sorry, people! I have just noticed that the link I typed was incorrect. The correct link is:


      French President Sarkozy and German Chancellor Merkel announced last week that an FTT will be introduced in the Eurozone in September. But the US and Canada are not on side. Likely, this is because a blanket FTT taxes transactions that are functional for actors in the real economy as much as transactions that are dysfunctional from the point of view of the economy as a whole. The paper in the link above describes how the blanket FTT solution can be refined to avoid that problem.

  5. I agree in a way with Financial Transactions Tax as it would be an attractive vehicle for raising revenue that is efficiency enhancing.

  6. Yglesias makes the undeniable case (this blog, 16th response) that intelligently targeted taxation is a good way to shift energy expended by people in an economy away from unsustainable addictions. So I was heartened when I read in an IMF update this morning the following in an interview of IMF Managing Director Strauss-Khan by Stern:

    Stern: The banks are making fat profits again, paying out billions in bonuses to their employees.

    Strauss-Kahn: Yes, and that’s the problem. This way another crisis may happen any time. The system is still far too unstable.

    Stern: Banks are dealing mainly in other people’s debts, in fact with some €120 trillion. Should the financial sector shrink and be made smaller?

    Strauss-Kahn: I share that view.

    Shrinking a sector with the volume of voice power that the financial sector can put out is not something I myself would expect to have much luck doing! But I can suggest that, no matter what else the addicts of gamesmanship in the financial sector may say to the politicians, regulators, and the general public, some will be entering a phase of life in which their enterprise and application will be wanting to regain more personal integrity, which means authenticity, of course. And that’s a key thing for everyone to keep in mind because it’s also true that a third of all alcoholics who enter AA actually stop drinking and start prizing authenticity and genuine empathy!

    What, therefore, will induce more rapid exit from building the aquifers of rent-seeking that financial sector bonuses on bubble-fuelling derivatives so often are? And what, AT THE SAME TIME, will induce more rapid entry into the exciting life of supporting the many transitions necessary to a globally more sustainable economy, i.e. one both more just and more green?

  7. […] The federal alcohol tax’s inflation-adjusted value is currently much lower than it was in the 1950s even though the country as a whole is much richer. Mark Kleiman observes that putting it back up closer to where it was would bring in on the order of $15 billion a year in net revenue, after adjusting for the (entirely desirable) reduction in volume […] in addition to the revenue it brought in, reduce violent crime and auto fatalities by something like 5% each: that’s about 800 fewer murders, 10,000 fewer rapes, and 1700 people not killed on the highways. To me, that sounds like a better idea than cutting spending on anti-poverty programs. And, of course, there’s the idea of a Financial Activities Tax as proposed by the International Monetary Fund. […]

  8. “All this doesn’t mean we rule out an FTT in other contexts—but it is not the most effective way to address the task at hand.”

    Mr. Cottarelli:

    Doesn’t almost everyone now agree that purely speculative capital flows (casino gambling) can be highly disruptive to the best and most nobly practical plans? Those who don’t agree seem to me to make the point that some disruptions brought about by carefully planned derivative bets are necessary to generate the energy to eject incompetent “leadership”. Yes, but it’s also worth pointing out to such people that by the time of the Lehman failure the overall role of speculative flows was very much more disruptive than virtually everyone in retrospect would agree was optimal.

    So I hope you and Mr. Lipsky and your indefatigable. courageous, and increasingly candid Managing Director will be taking this point to the G-20 process in time to get a SMART FTT in as binding a paragraph in the final Seoul communique as possible.

    Should any of the three of you need any ideas/exhibits for getting this point across, I hope you will not hesitate to visit the following URL:

    http://www.authentixcoaches.com/NeedCapitalCycle.html .

    The paper there has been written with the help of an international group of people from many sectors of the global economy (including one of us who was a former JP Morgan managing director and a member of that bank’s Long-Term Capital Oversight Committee)

  9. Sweden has tried a transaction tax and it clearly didn’t work. The gains were negative (decrease in capital gains), volatility increased, main street suffered, and business was lost to London. This attempt at a tax also caused a loss of jobs. Adding to that a decrease in volume will cause higher bid/ask spreads in all markets including futures which in turn will cause higher commodity prices (coffee, oil, OJ, etc.) plus the tax will be passed down straight to the consumer.

    Not only will the public see this tax increase there prices but also decrease the interest paid in there bank accounts, a hit from all sides. The IMF knows this and that is why they have been against this in all of there reviews including the one that came out a few days ago. Many of the leaders also know the negative implications of such a tax which is why they are favoring an insurance fee on banks as this wont have the negative impact on consumers.

    • Yes, Andy, Sweden tried an FTT and lost jobs and profits to London. Is that an argument for ignoring, in the G-20 Forum, the idea of a much smarter FTT than Sweden introduced? Of course not. That’s why there’s a G-20 Forum. Granted, it may take the G-20 deliberators some time to agree on the compromises between the countries with big financial sectors and those lacking them to introduce a smart FTT globally. But the price of not doing so — uncertainty everywhere and diminishing confidence in the long-term investments that are the hallmarks of truly healthy economies almost entirely because we have not, in our love affair with free markets, yet perfected practical means to limit the Ponzi schemes that complex derivatives are — is escalating very steeply, as must be obvious from Ms. Lagarde’s remarks this week and those of a rapidly growing of other high-profile people.

      The other points of your contentions about FTTs are not incorrect, but they are not weighted against the alternative cost of inducing more honesty in the financial industry and its adjuncts in corporate, government, and, I must say, also academic life. Let’s rememember that a financial and an economic system is basically a communication system among people born with the potential to be decent or indecent human beings. If the system that operates at any time is tilted to reward indecency more than decency, as is currently the case by the vote of billions of disappearing middle class people in the economically developed countries, then a cataclysmic crash will sooner or later occur, and the necessary but not sufficient way to restore it to decency is to make the rewards for honesty greater than for dishonesty.

      If anyone wants to explore this subject further in a PRACTICAL way, then I can suggest, having many times been a coach to would-be honest people facing desperate circumstances in which the temptation to contribute convenient untruths was acute, the following URLs:

      1. A narrative of a successful turnaround of a 50-person construction company

      2. Some testimonials from a variety of life situations in which proficiency was gained in the honest application of this verbal format

      3. A definition of honesty and related value disciplines that has been of practical help to several organizations and many individuals

      4. An overview of the psycholinguistic theory explaining why this format (I have ‘X emotion’ now — or IHXEN as an acronym that we pronounce “Eye-Zen”) works to lead, in the measure one practises it — to the recovery of safe honesty in relationships

  10. […] IMF website has published a blog on the report, including a section explaining its position on a financial transaction tax (FTT) in its report: […]

  11. The prescriptions of the IMF could at best be adopted by the banks of the industrialised countries. Why, for a crisis whose origins lay in the untrammeled functioning of the financial institutions in industrialised countries, the banks in countries like India, which weathered the storm well, should be put on a procrustean bed. This is a western way of thinking–never acknowledge anything good in other countries. Did any U.S. Federal Reserve or U.S. Treasury official come to India to study how India managed the crisis?

    The suggested taxes may be imposed as a psychological props but they will be peanuts when a crisis is big as it was. We should not look for palliatives when surgery is required. Western countries are not yet prepared to accept the fact that their control systems were weak, subject to the pressures of the highly paid bankers as most in high positions in the U.S. govt. keep flitting form the private sector to the Government and do not want to hurt themselves by regulating pay or bonuses.

    The banks are trusted by billions of depositors with their hard-earned money and the governments have a fiduciary responsibility to protect the depositors from the ravages of the bank executives. By these new levies, the banks will try to pass on the buck literally through various other charges to keep their profits untouched — just as the incidence of income tax can also be shifted backwards.

    The IMF produces verbose papers using different terminologies to suit different times. When the Asian Crisis came they talked about the New International Financial Architecture as kingdom come. But none of those elements were used to scrutinise the US, U.K. or other banking systems as the KING CAN DO NO WRONG.

    It is time that this attitude is given up and let the IMF study how India, China, and certain other countries stood up to the crisis and learn lessons from them. There is nothing wrong in learning from others.

    • Couldn’t agree more with you Sivaraman.

    • Dear M.S. Sivaraman,
      I agree and further suggest that North Atlantic nations with failed banks should also study loan-regulated, non-failed banking sectors and economies of S.E. Asia, including Australia. Independent Canada also boasts a thriving economy, largely unaffected by 2007 events.

      With new capital now shifting to Hong Kong and Singapore, stifling regulation proposals forced upon unaffected countries would further ensure off-shoring of their financial sector businesses – for the most part as a result of European self-interest pressures.

      Dr K. Henry’s (the Australian Treasury’s highly respected independent taxation reviewer) recent report to government outlined the adverse and debilitating effects that would flow from any form of transactions tax. Dr Henry’s position illustrateed that government’s wisdom in its formal rejection of such an impost.

      Indeed, successful economies are worth emulating. Potentially destabilising regulation pressures currently being promoted by fiscally under-performing entities are unlikely to attract wider international adherence.

  12. […] an excellent blog on the IMF site, the paper’s lead author Carlo Cottarelli explains the […]

  13. Can anyone explain why insurers and reinsurers are included? With one very notable exception, insurance groups were not affected by the crisis and traded thru without bail-outs.

    • IMF response:
      The proposal to subject insurers to the financial stability contribution (FSC) is not because they necessarily caused the crisis or because they received explicit tax payer support. Instead, they would be included in the FSC (together with all other financial institutions) because of their substantial participation in the broader financial system as they too derive benefit from the increased financial stability that results from a better resolution regime.

      While benefiting from this public good, the amount that specific institutions would contribute would depend on base and rate, and in this regard, insurers would not be treated the same as banks. The paper describes that the FSC at least initially could be a fixed-rate charge on a balance sheet base that would differ by institution type, with the intention that the base reflect riskiness and systemicness in select activities. As a consequence, while insurance companies are within the regulatory perimeter, the chargeable base will be smaller.

  14. […] next piece that’s peaked my interest is a fairly wonky link to the IMF and a discussion about putting taxes on banks to make them pay for the mess they made of the world the last few years.  The report was supposed […]

  15. […] Preview of IMF June bank tax recommendations to G20 – iMFdirect […]

  16. There is no such thing as a non-fail bank nation, there are just nations where the global leverage bubble has not popped yet. Expect some fireworks in Spain, Australia, Canada, China… Overleveraged banks can see their capital wiped off faster than you think.

  17. […] – The IMF taxes; or, ‘I come to bury Caesar, not to bail him out‘. […]

  18. “Should everyone do this?

    “Several countries that did not need to pour large resources into their financial institutions are naturally reluctant to lumber them with more charges.”

    We strongly agree with this assessment.

    Financial institutions should only be encouraged to guarantee their risk level. All taxes are passed on to consumers. It is understandable that several G-20 leaderships do not want to further tax their most profitable non-failed employment sectors.

    There is no justification for lumbering well-managed private companies with a financial transaction tax, or a punitive counterpart ‘speculation’ measure, in order to prop up foreign banks that foundered due to bad lending practices.

    Well-intended focus on repairing the banking sector and ensuring its ongoing stability has, in some external quarters, morphed into an unhealthily targeted hatred of profitable taxpaying businesses, a collective humiliation of innocent financial sector employees, and a hatred of honestly achieved prosperity.

    There’s also an ungraciously promoted idea that taxed money, on recommendation from the IMF, should be commandeered from private financial sector businesses for redistribution to favored causes – and possibly to a displeased wider public’s non-preferred organisations.

    The IMF’s final report will be handed down in June, almost three years after the GFC. Non-failed bank nations that choose not to further tax-burden their citizens deserve some level of closure in order that they may proceed according to their internal circumstances.

  19. Financial Stability Contribution: I am not so convinced we have no resolution mechanism and I feel like it’s supposed lacking is often used as an excuse to hide the lack of political will. In this respect I would not like to see governments obtain funds, by means of a Financial Stability Contribution, only to allow political will to be even scarcer.

    Cost of the crisis. Let us never forget that no tax on our financial sector would produce as much tax revenues (and jobs) as having our financial sector work adequately for the economy and for us.

    And in this context let us not forget that the cause of this crisis was precisely the tax on risk invented by the financial regulators and which made the financial sector orient itself more towards securities backed with subprime mortgages, because these managed to get themselves some AAA ratings and therefore generated only 1.6 percent capital requirements for the banks; and away from the small businesses and entrepreneurs because lending to them required the banks to have a heavier 8 percent capital.

    Financial transactions tax: I support financial transaction taxes, but only if they are minimal, so to serve as “speed bumps”. I would never support it as a tax revenue raiser, since I am old enough to know who in the long run ends up paying those taxes… borrowers and citizens.

    Now if you want to read some of my quite related comments on global insolvency initiatives in 2003, while an ED of the World Bank, I invite you to http://bit.ly/971uCr

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