Yes, but a bank tax won't do it. Photographer:Mark Ralston/AFP/Getty Images
Yes, but a bank tax won't do it. Photographer:Mark Ralston/AFP/Getty Images

Representative David Camp of Michigan wants to lighten the burden that some large financial institutions place on U.S. taxpayers. Unfortunately, the bank tax he proposes might actually make things worse.

To be clear: As legislation, Camp's plan appears doomed, despite some admirable aspects, so it's unlikely this tax will ever be levied. All the same, it's worthwhile to examine the flawed theory that Camp's supporters use to justify the tax.

Under his plan, systemically important companies such as JPMorgan Chase & Co., Goldman Sachs Group Inc. and American International Group Inc. would pay a quarterly excise tax of 0.035 percent on assets exceeding $500 billion. This would bring in about $86 billion over 10 years, and thus help Camp lower tax rates without increasing the federal budget deficit.

At first glance, this might look like fair payback. When the government came to the banks' rescue during the financial crisis of 2008 and 2009, it put hundreds of billions of dollars of taxpayer money at risk. This helped train the market to expect similar government support in future crises, so that large banks can borrow money at lower cost than they otherwise would -- a taxpayer subsidy estimated to be worth tens of billions of dollars a year. On that background, Camp's 0.035 percent tax looks like a small price to pay.

Problem is, the tax is a blunt instrument. It punishes all big banks, irrespective of the threat they present to government coffers or the broader economy. And while a levy on assets might encourage some banks to get smaller, it also risks enshrining bailouts: As long as a bank pays up, it can operate with dangerously low levels of capital -- and feel entitled to receive support if it runs into trouble.

Worse, the tax might push banks to take greater chances, using more borrowed money to invest in riskier assets, in the hope of generating enough added profit to cover the cost of the tax.

A better way to take bank risk off taxpayers' shoulders would be to make banks less likely to fail in the first place. The largest U.S. bank holding companies have, on average, loss-absorbing capital of about $4 for each $100 in assets (under international accounting standards). That means a loss of just 4 percent of assets could render them insolvent. Regulators have proposed raising the minimum capital requirement to 5 percent. There's good reason to believe that higher levels would benefit the economy by lowering the risk of crisis.

The savings to taxpayers could be immense. The cost of financial crises goes far beyond bailouts. The attendant economic malaise lowers tax revenue, boosts spending on social programs and potentially does permanent damage to the country's productive capacity. The ultimate cost of the 2008 financial crisis in the U.S. is estimated to be at least $6 trillion, and possibly more than $30 trillion.

Perhaps the greatest danger of a bank tax such as the one proposed by Camp is that it could steal momentum from setting new capital requirements and taking other steps that would actually make the financial system more resilient. The desire to punish banks for the last crisis shouldn't get in the way of averting the next one.

To contact the editor responsible for this article: David Shipley at davidshipley@bloomberg.net.