Banks, Bishops and Robin Hood

Suppose you have £100 in your pocket. You know at some stage you are probably going to need to use it to pay for something but not today. Maybe tomorrow but not today, so you lend it to a bank for a day and they pay you some interest and tomorrow you get back £100.02.

The next day again you don’t need your money so you lend your £100.02 back to the bank and the day after you get £100.04. You continue doing this every day making a daily 2p profit until a month later the day comes when something crops up and you need to use your £100. In that period, because you invested you have made a 60p profit compared with having just kept the £100 in your pocket.

That’s all nice and easy. Now suppose that the taxwoman comes along and every time you transact with your bank she charges you 1p.

(Why do people always assume that a person working for the IRS is a taxman? This time it is a taxwoman – I am fighting for equal opportunities.)

With this tax in place it is still profitable to do the investment but your profit is reduced to 30p, having reinvested your money every day for 30 days and having been charged 1p each time.

If you are feeling a bit miffed at losing half of your profit there is an alternative. Rather than invest your money for one day 30 times in a row, you could invest it once for 30 days. Since you are now doing just one transaction instead of 30 you will pay just 1p to the taxwoman and walk off with a healthy 59p profit. Hoorah! Take that you thieving taxwoman!

There is a downside though. The nice thing about the first option was that each day you got your money back. If you needed it to pay an unexpected bill you could do so and if nothing unexpected came up you could just reinvest and have the same choice again tomorrow. By moving to the single 30 day investment you have in fact made a bet. You have bet that at no time in the next 30 days will you need to access that cash.* If after 20 days you do have an unexpected bill to pay then you’re in trouble.

In effect, what the taxwoman has done, in trying to raise revenue, is unwittingly made you take a risk. Having easy access to your money was very expensive compared with not having any access to it for a month. You thought it was worth the gamble.

Of course, the profit of 30p or 59p is unlikely to make anyone bother to invest at all but scale this up to the amount of excess cash a bank might have on a particular day, which could be tens of millions of pounds and suddenly the difference between the two options becomes something to think about. Should they invest it daily knowing that they’ll get it back the next day should they need it but making a small profit or should they invest it longer term knowing they’ll make a bigger profit but might be in a pickle if they need it unexpectedly?

Irrespective of what they decide, the taxwoman has given them a new incentive to take a risk.

This week the Archbishop of Canterbury came out firmly in favour of such a tax. He is backing a tax on financial transactions known as the Tobin Tax (after American economist James Tobin who first proposed the idea back in 1972).

While I think taking economic advice from a clergyman almost as absurd as taking it from a politician, I do see why the Tobin Tax, (recently rebranded in the UK as the Robin Hood Tax) has gained popularity. These are some of the things I have heard about it:

• The tax is a good idea because it would stop banks taking risks
• The tax is a good idea because it is only tiny in the grand scheme of things and it would still raise lots of money
• The tax is a good idea because the banks caused the mess so they should pay to clean it up

I’ll take each of these in turn.

It would stop banks taking risks

As I showed in my simple example of investing spare cash (traditionally a low risk activity) this tax gives an incentive to move from a safer strategy to a more risky one. It is simple enough to see in this example but apply it to the complex things traded between banks (which 2008 showed us even they don’t understand) and we really don’t know what effect it would have on the market in terms of risk. It would most likely lead to fewer, bigger, longer term transactions and those are simply more risky not less.

The tax is tiny and will raise lots of money

That doesn’t make sense – they can’t both be true. Rowan Williams thinks the tax could raise $400bn each year. According to this McKinsey report, global banking profits last year were $712bn. Are we honestly saying this is a small tax that the banks won’t notice? That’s over half their profit!

Will it raise lots of money? Probably but remember, banks are experts in passing on the costs of something on to their customers. If you want to borrow some money when such a tax is in place, what is to stop the bank just giving you a worse rate to compensate? In doing so it isn’t the bank paying the tax, it’s you.

Banks caused the mess so they should pay to clean it up

The banks did cause the mess and they should pay towards the clean up. If you think that such a tax is going to recoup what they cost us though, think again. I would broadly estimate that the total cost of the problems caused by the banks will have a negative effect on the UK economy alone to the tune of several trillion pounds. Sorry, that’s never coming back.

Also, just because the banks should pay towards the clean-up doesn’t make the Tobin Tax a good way of doing it. If we decide to go after the banks a simpler way of doing it would just be to tax their profits. If we did that at least we wouldn’t push them towards risky trading strategies even if they would still probably try to pass the extra costs on to us.

You can therefore summarise from this that I don’t think it’s a particularly good idea. Please don’t misunderstand me – I would love to get some money back off the banks. I just can’t see this is a good way of doing it. Branding it The Robin Hood tax was a stroke of genius – take from the rich and give to the poor etc. It gives the tax a certain romantic quality and I think that’s where a lot of its political support comes from.

Sadly though, a tax is a tax and romance can play no part in differentiating a sensible one from a bad one.

RedEaredRabbit

*Additionally, putting money on deposit for a longer term opens the lender up to increased credit risk as if the borrower gets into difficulty during the period the lender can’t just decide to get their money back and reinvest elsewhere.

P.S. As with all of my posts this is purely my opinion and I’m not saying that my opinion is definitely correct or any better than anyone else’s. As always, whether you agree or disagree with me, I am happy to hear your thoughts.