Friday, January 15, 2010

Tax Evasion?

In the last few days we have seen a ton of headlines and articles talking about how President Obama is going to tax the major banks of the country (including US branches of foreign banks) in order to recoup the bailout funds paid to the banks that went to save them.

The President pledged to “recover every single dime the American people are owed.”

Remember that Mr. Obama is the protector of the dime since he vowed that the health care plan would not cost the American public “one dime”!

The estimated bottom-line cost to the banking system is about $100 billion over a ten-year period.

The banking system is, of course, lobbying as hard as it can to prevent such a tax from being levied. And, lobbyists are earning a lot of money off of this.

But, the President has heard the voice of the little people who are angry at the bankers.

Oh, and then there is the need for new bank regulation.

The estimated cost of this new regulation is in the billions of dollars.

The banking system is, of course, lobbying as hard as it can to prevent such regulation from being inacted. And, lobbyists are earning a lot of money off of this.

But, the President has heard the voice of the little people who are angry at the bankers.

What can we bet on?

My experience in running banks and in studying banks and the banking industry is that the big banks will not, ultimately, pay much of the bill at all.

The reason for this is that the banks will find many, many ways to get around any new laws, regulations, and taxes or will pass the cost of the new laws, regulations, and taxes on to others.

Let me just say here that I don’t mean to single out just the banks in this area. In this Age of Information and with a global network of business and finance almost everyone that has wealth or financial clout or is big can find ways to avoid laws, regulations, and taxes. And, if you don’t believe this it just shows how good these people and organizations are at evading them.

And, the people and organizations that can evade or avoid these new laws, regulations, and taxes the best are the ones that the President and the “populists” are after. The people and businesses that are the least able to avoid the new laws, regulations, and taxes are those that can least afford the consequences of the new laws, regulations, and taxes. This will include the small- and medium-sized banks and people from Main Street. This has happened over and over again throughout history.

Just an example: in the 1960s it was almost the mantra of a certain brand of economist that a little inflation (an inflation tax, if you will) would help the “little people” because it would result in more employment. This was captured in something called “the Phillips Curve.”

The result? In the short run employment was a little higher but people found that inflationary expectations adjusted and over a longer period of time it took more and more inflation to sustain the small rise in employment associated with the higher inflation. By the end of the 1970s we had a real crisis!

Furthermore, those with more wealth or who were better connected could protect themselves from inflation. They could purchase assets, like homes, and art, and securities that appreciated in value with increases in prices. The less well-to-do or the less well-connected could not do this and so the wealth distribution in the country became more skewed.

Thirdly, higher and higher inflation affects productivity and this impacted the use of existing capital and the hiring of the less educated and less trained worker. Unused capacity in manufacturing and under-employment rose over time again hurting those that were the least able to protect themselves.

The purchasing power of the dollar declined from 1961 to the present: where one dollar could buy one dollar’s worth of goods at the former time, it could only buy 17 cents worth of goods now. And, who has suffered the most? Main Street and not Wall Street!

There are two forces dominating the banking scene right now and neither one of them can lead to the construction of sound banking regulations and banking practices. The first is the emotion of the present. People may be upset about what has happened and are particularly incensed at the profits that the large banks are posting. However, an emotional response to current events cannot lead to a rational result. Basing laws, regulations, and taxes on a populist outburst will only produce consequences that are regretted in the future.

Second, it has been my observation that politicians only fight the last war. This is popular because the “last war” is discussed in the press and it is what the constituents of the politicians are responding to. Furthermore, the issues are so complex that the politicians don’t even understand what happened in the “last war”. If you don’t believe this take a look at the initial work the Financial Crisis Inquiry Commission.

Finally, the big banks that the politicians are going after have already moved on “light years” ahead of what happened in the “last war”. I have written several posts on this very fact. Thus, the politicians are firing at the wake of a rapidly moving boat and will miss their target by a lot!

Oh, well, politicians have to get their 15 minutes of fame and try and get re-elected: Seems like we could spend our time concentrating of more productive efforts.


If anyone should be congratulated for the massive profits that have been posted by the “big banks” over the past nine months it should be Ben Bernanke and the Federal Reserve System. Since the real strength of the earnings, especially in banks like JPMorgan Chase, have been in investment banking and trading, one can argue that the Federal Reserve policy of keeping short-term interest rates near zero has subsidized the pockets of the big bankers. Thus one could ask if any of the huge bonuses being paid out by the “big banks” are going to the Chairman and his officers in the Federal Reserve System. They certainly deserve them!

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