Windfall taxes cannot be the answer
IF TAX policy were determined by referenda, London’s financial institutions would be in even greater trouble than they already are. I was a guest on James Max’s LBC radio show yesterday and it was soon clear that the overwhelming majority of callers hate banks with a passion. My own position, which is that it would be madness to shut down the City, ban bonuses or centrally plan mortgage rates, was given short shrift. Yet opposition did abate when I pointed out that the average total tax on bonuses is around 50 per cent – and that is before any of the money is actually spent, when another chunk goes on Vat, stamp duty and the rest.
Even after the bailouts – which have not in fact been as large as most people realise, though there is no excuse for any handout – the City remains a massive net contributor to the Exchequer. Yet Labour and Tories alike realise that there are votes to be gained in attacking those who work in finance, so we can expect an escalation of hostilities in the run-up to the general election. There is now a high chance of a supposedly one-time windfall tax regardless of who is elected.
The problem with windfall taxes, which to Margaret Thatcher’s ever-lasting shame she introduced to the UK in 1981, is that they set a dangerous precedent. If you launch a one-off tax raid on one unpopular industry, why not on another? Once the banks have handed over a couple more billion, who will be next? One could easily imagine a one-off windfall tax on pension funds – after all, the markets have bounced, which is one definition of a windfall. Housing is another obvious target. A just law is one that treats everybody equally, which means that a windfall tax on one industry is discriminatory, unjust and a flagrant case of what Alexis de Tocqueville called the tyranny of the majority.
On a more prosaic level, “one-off taxes” undermine trust and certainty, one of London’s core advantages against lower-tax jurisdictions such as Dubai or Singapore. If the British government can no longer be trusted not to impose retroactive taxes on a whim, then the UK will lose one of its remaining selling points in the great battle for global capital. There are many other flaws with the idea of a windfall tax: it is only once pay (and other costs) have been subtracted from revenue that taxable profits are determined. So a windfall tax would have no real effect on bonuses. Taxing profits would also go against another of the government’s key policies, which is to get the banks to put much more capital aside. Yet capital, by definition, is retained profits; so the policy would be deeply counter-productive.
This row also confirms that bailing out bust banks has turned out to be a disaster. It has turned the public against all institutions, even those that didn’t take government cash. In future, insolvent banks must be allowed to fail; governments must develop new bankruptcy and wind-down procedures for complex financial groups. Banks need to produce living wills telling regulators how all of their transactions and contracts can be unwound; it must also become easier for outsiders to understand exactly what impact one firm’s bankruptcy would have on all of its counterparties. That is for the future: in the short-term, there will be no avoiding the backlash. Let us hope it doesn’t spiral out of control.