Countries trade on their reputations. It is not just the number of eager, materialistic consumers that causes businesses to invest in one country as opposed to another. The hospitality of the host nation – and especially its government – is also of huge significance.

Two of the most the attractive features investors will consider are private property rights and the rule of law. The reasons are obvious. Without protection of private property, investors cannot guarantee that they will get to keep the proceeds of their investment (or even the initial stake). Whether it is petrochemical firms being bullied out of half their shares in Siberian oil and gas fields, or banks having their profits taxed heavily, the effect is the same: the investor will look elsewhere in the future. The same follows for the rule of law: if politicians can use the tax authorities to attack those that are both successful and unpopular, investors will steer clear.

Of course, one might argue that no investor will be deterred by the decisions of Gordon Brown and Alistair Darling. In six months time they will be nothing more than economic bogey-men; names that bankers use to scare their children. Their ability to do harm will have ended at the ballot box. So how much harm can a windfall tax on bank bonuses really do?

Firstly, the election may change nothing. George Osborne wouldn’t rule out a windfall tax on bank bonuses either, while Vince Cable wants to tax bank profits to create an insurance fund for the sector.

But more importantly, in the minds of investors, even a one-off windfall tax conveys the message that British politicians view high profits or incomes like bandits view a passing caravan.

There is a real issue regarding taxpayer liabilities: the banks owe vast sums to the exchequer, so Vince Cable may be right to say that “a special tax on the banks’ profits” should last as long as the “banks continue to depend on taxpayer guarantees”. The banks certainly should pay their debt off as quickly as possible – though it would only delay repayment if taxes damaged the banks’ ability to generate the profits from which the debt must be paid.

But it is entirely different to say that banks profits should be taxed more heavily than those of other businesses even after the debt is paid off, or that individual bankers (who are needed to generate the profits from which the debt will be paid, and who will only do so if they have incentives to do so) should be the targets of a special tax regime. Hitting those who generate wealth with high taxes may indeed drive talented people and successful institutions abroad. More importantly, applying different laws to different groups undermines a free society and damages the fundamentals of the economy. That’s no way to end a recession.

3 thoughts on “A windfall tax on bankers will damage the economy”

  1. Posted 08/12/2009 at 10:43 | Permalink

    I remember once arguing with my MP Quintin Hogg (later Lord Chancellor as Lord Hailsham) against the retrospective nature of the War Damage Bill in 1965. Even though a distinguished lawyer, he simply couldn’t understand how an ordinary voter — and investors — would regard it as seriously damaging.

    I think one of the problems is that politicians seem to live in a world of their own (the Westminster/Brussels bubble). Maybe we should have a rule that MPs can’t be re-elected more than, say, twice. That way there would be a limit to the extent of their ignorance of reality.

  2. Posted 10/12/2009 at 11:43 | Permalink

    The attack on bankers assumes a kind of collective guilt – like taxes on Jews under the Nazis, or Stalin’s treatment of the kulaks. Yes, a ridiculous exaggeration, but what does Darling know of the reasons for bonuses and the role which individuals have played in particular banks? HSBC and Barclays didn’t take public money but are still deemed to have benefited from bank guarantees. This argument could be used to justify arbitrary imposts on any sector – doesn’t Tesco benefit from the police arresting shoplifters?

  3. Posted 13/12/2009 at 21:42 | Permalink

    There is a rational argument that a windfall tax on bank bonuses would prove unhelpful. But an interesting question is why does society want to tax bankers so? At the root of this is a very real anger that an industry that has pushed the western economies into depression, costing jobs and wealth thoughout society are so insulated from the moral world the rest of us inhabit that they can consider paying themselves these bonuses. Len – to compare this to the Nazi taxes on Jews is inane. Society can’t tell you who exactly ruined the banking system, any more than they can tell you who is resposible when their electricity supply fails, but they wouldn’t pay the electricity company bonuses either.

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