Vince Cable’s banking tax doesn’t help anyone

Vince Cable – one of the few politicians to emerge from the financial crisis with his reputation enhanced – wants banks to pay an additional 10 per cent on their profits in return for the trillion pounds the taxpayer has sent their way in financial support. The Liberal Democrats argue that such a levy would raise around £2 billion a year for the government’s coffers, as well as reducing the amount of cash banks have available to pay eye-watering bonuses.

Unfortunately Mr Cable has succumbed to the temptation to crowd please. There is no doubt that banks owe a great debt to the British taxpayer for saving their skins, and are entitled to want their pound of flesh in return. But a new tax is the wrong tool for the job. Not, as suggested by the British Bankers’ Association, because a new tax will lead to an exodus of banks, and jobs, from the UK. Even hedge funds, with far greater geographical mobility, are reluctant to leave London.  A new tax is a bad idea because it won’t work.

First, it won’t raise much: banks have expert teams that do nothing but work out how to reduce their employer’s tax bill. The mooted £2 billion is almost certainly an overestimation. Levying the tax bill will also have a cost to HM Revenue and Customs – so the amount of money eventually reaching the Treasury is unlikely to make much of a dent in the UK’s deficit.

Second, the tax will hurt ordinary people, not bankers: the proposal will not affect bankers’ bonuses. Bonuses are paid out of revenue, not profit, so will be undiminished by the tax. Shareholders are the group that will suffer most, as they receive their dividends from after-tax profits. Who are some of the biggest holders of bank shares? Pension funds and insurance companies – not the targets Mr Cable is intending to punish. And there is little doubt that banks will use government interference as an excuse to cut lending and raise the cost of borrowing, passing the cost onto the consumer.

Third, it makes the real problem worse: short-term regulatory measures, ‘special’ taxes and political posturing succeed only in making banking less competitive. New entrants struggle to navigate regulatory requirements, cannot afford profit taxes and are too small, and too poor, to lobby the government as effectively as the big boys. Putting up these additional barriers to entry means existing banks just get bigger – making it even harder to let them fail.

Banks should have the decency to return some money to the taxpayer whether they received government support or not. Shareholders should be more active in managing staff remuneration. That neither is likely to happen does not mean the government should try to control these decisions. The appropriate field for effective state intervention, as this blog pointed out last month, is to make banking more competitive. The Lib Dems are right to want to split up the banks – and Mr Cable would be better advised to focus his talents on developing a sensible policy for doing so.