There’s been a few interesting posts recently (see bottom of post) about how one of the issues we have currently is we have companies that are considered “too big to fail”. That we have to bail out banks, because if they fail, the economy breaks down totally, and it’s not a far jump from that to rats gnawing on your cold lifeless body in the street.
I was at a Yeah Yeah Yeahs gig last week, and between the support act and my second favourite half Korean coming onto stage, the solution dawned on me, as blindingly obvious.
Every time (not this year but the last 10) a company (Oil/Banking/etc) makes ludicrous profits (Billion dollars a second yadda yadda) everyone’s up in arms, as it’s immoral and wrong and we should impose a windfall tax.
I’m against windfall taxes. They sound like a good idea, but I think they’re mostly desired out of misplaced moral outrage (under the false assumption no one should make that much money) and not any decent economic reasons. If companies are making money be being anti-competitive, then competition authorities should come down on them. If it’s just a result of running a successful business then well done to them and we should move on.
I do however have a massive issue with bailing out these companies after they spent year after year declaring ludicrous profits. Yo banks, I’m looking in your direction.
The solution of course is not a ‘windfall tax’ but a bailout tax. When companies reach a certain size such that their failure would have impacts beyond their market and into the general populace, they have a choice. They can spin off sections of themselves into independent companies and slim down such that the failure of any single part would not have severe economic consequences.
Or they have to pay a bailout tax. This tax money would go into a government reserve (some fiscally stable system) and not general taxation. And when companies fail this money is drawn on to bail them out. This saves us printing new money (cough sorry quantitative easing) or borrowing such that my friends’ children will grow up in debt having to bail the lot of us out.
Now of course if a business doesn’t fail, the money goes to bail out businesses that do. That’s how insurance companies work and well let’s be honest, we need a few more insurances. And businesses don’t have to pay the tax. They can avoid the tax, by avoiding being too big to fail; otherwise when you’re declaring £10 billion a quarter in profit, you can pay a hefty chunk of that to make sure it’s not frigging me that’s bailing you out.
I want my tax money to go to something useful. And bailouts are not useful, but needed when things have gone too far wrong. I shouldn’t be the one paying for your mistakes.
If you’re interested two good articles on why we shouldn’t allow companies to be too big to fail:
Resilience in the Face of Crisis: Why the Future Will Be Flexible
The recognition that failure happens is the other intrinsic part of a resilience approach. Mistakes, malice, pure coincidence—there’s no way to rule out all possible ways in which a given system can stumble. The goal, therefore, should be to make failures easy to spot through widespread adoption of transparency through a “given enough eyeballs, all bugs are shallow” embrace of openness, and to give the system enough redundancy and slack that it’s possible to absorb the failures that get through
Ten principles for a Black Swan-proof world
What is fragile should break early while it is still small. Nothing should ever become too big to fail. Evolution in economic life helps those with the maximum amount of hidden risks – and hence the most fragile – become the biggest.
1. Andrew
Isn’t that what the FSA is in effect doing by forcing banks to hold government bonds: FT - UK banks face being forced to buy bonds
The “insurance” is in fact forcing banks to make sure their balance sheets aren’t over extended in risky asset classes.
2. Adrian
So that only covers banks, not all businesses.
And it (as far as I can tell) only helps prevent banks fail, by ensuring they have a certain amount of liquid assets nor are over extended.
But if it fail, for any reasons, it would still need a bailout.
So I think my concept applies still. If you as a company weather your a bank or a car manufacture or a large employee or a supermarket chain … and get to the point where should you fail you would need a bailout. Well then that bailout money can be drawn from the bailout tax you paid during the good years.
3. Andrew
The current crisis was caused by banking/finance, not by other businesses.
Other businesses that are in real trouble now (for example - massive US car makers) should be allowed to fail, they have failed time and time again to modernise and don’t represent anything that looks like a good business.
4. Adrian
Oh I agree. As do most economists I believe.
Yet they are being bailed out. Because of politics or jobs losses during a down turn or what not.
I still think my point fails. If their are ever going to be bailouts they should be paid from profits of the business that have grown to a point where they need to ask for bailouts to prevent failure.
Whilst this applies especially to banks, I think it should be applied all round.
5. Marc
How are you deciding who is too big to fail? What is the criterion? is it a hard number?
If a foreign company has a “too big to fail” imprint in the UK would they have to abide by British regulation?
Am I correct in thinking that the difference between a windfall tax and a bailout tax is that the money just sits in a reserve doing nothing for possibly a decade or more?
If you are a car manufacturer or supermarket with tight margins and low profits, a scenario where you qualify for the bailout tax but not a windfall tax, what does splitting up entail in these two industries?
If Apple’s failure triggered a mass suicide of MacFanBoys would they be classed as too big to fail, how would they be split up. Would they have to abide by British regulation to sell in the UK?
6. Adrian
Economic Criteria. Decided by economic people smarter than me. Or regulators. Or competitions authorities. Or a special board. The criteria would be something along the lines of
If they’re paying tax in the UK and would need a UK bailout if they collapsed then yes. If they would never get a UK bailout then no.
Well assume bailouts happen, the money would be used to bailout other companies collapsing. If they don’t I assume the money would be put in some low risk economic mechanism.
To get that big you must have been making big enough profits at some point. That’s when you’d be paying the tax. As I said, you don’t have to pay the tax if you keep structuring your company differently and spinning off components such that it would never be to big too fail. I think this would be a good economic side effect.
Apple has $25 billion dollars in the bank. Some of this would have been paid in bailout tax should they have become too big. This money would be used to bail them out. For example, they could split out retail and non retail sides of the business if they want to reduce size. Or pay the tax.
Look, this isn’t an economic white paper with all the details hashed out. It’s an essay on how instead of calling for windfall taxes in the good years and bailing out badly run businesses in the bad years, we combine the two into an insurance against organisations where failure would result in a economic collapse.
Or in other words “balance”
7. Fer
Three problems with this approach:
The UK Government has to take into account international competitiveness. To impose an excess tax on large companies would simply create an incentive for those companies to move away from the UK (as some have already for tax reasons). So this would only work based on an international consensus - but then who is responsible for deciding who is too big to fail on a global scale? Would we rely on (say) the Bermuda authorities to bail out Bermudan headquartered companies which if they failed would significantly harm the UK economy? Unless the rules applied across the board and the fund were international (who would monitor it?) then they would be easy to avoid.
There isn’t a hard line between the companies which are too big to fail and which are not. It varies depending on what sector of the economy you are talking about. There is also a lot of politics involved - perhaps for Labour there would be union pressure to deem car manufacturers as too big to fail due to the jobs impact, which wouldn’t apply to Tories. So how do we decide where the line is? If you set some simple objective criterion (say profits, or balance sheet value, or number of employees) then this either wouldn’t catch all companies which would be “too big to fail”, or it would catch too many, depending where you set the bar. If you made it a complex calculation based on many factors then (just as happened with the FSA capital regulations, which were supposed to do exactly this i.e. ensure that banks had enough reserves to cover the worst case outcome and therefore not need bailing out) organisations would find ways to exploit those regulations (and would, indeed, due to market forces be forced to do so) so that they could maximise shareholder profits while just about staying under the threshold. So then when a problem happened you’d either have the government having to step in to bail out a company which hadn’t been deemed to be too big to fail, or choosing not to prop up a company which had paid the tax (see 3 below) - so creating a legal nightmare of claims from other companies which had been forced to pay the tax and yet not needed bailing out.
The companies which chose to pay the tax would end up in an anti-competitive position. Because their creditors (if not necessarily their shareholders) could guarantee they would be paid (unless the rules allowed some kind of discretion on the government to decide at the end of the day who gets a bail out) they would effectively be able to trade with no credit risk (dealing with them would be as good as dealing with the Government). This would allow them to exploit their position over companies which aren’t large enough to qualify for the guaranteed bail out, forcing them out of the market.
The reason the Fed allowed Lehman to collapse was an attempt to send a clear message that the Fed wouldn’t prop up everyone. This arguably backfired but the message was there. Without some uncertainty over who gets the bail out and who doesn’t the market doesn’t work.
8. Adrian
Fer, all good points. Clearly the idea needs more details worked out before released as government policy.
Regarding non UK based companies however not apply equally to a “windfall tax”? Also, if a company based in Bermuda failed, would the UK government bail it out?
Although we’re in no better position right now. The USA car companies should have been allowed to fail, and who knows which bank gets bailouts and why. We have no better clarity now.
Unless you structure a bailout such that you are buying a bankrupt company, in which cases creditors get no guarantees of 100% on the dollar/pound.
I still think my general trust makes sense, even if the execution is difficult. You don’t get to declare outrageously massive profits in the good years, and ask for a bailout when it turns bad.
9. Shirley
If you listened to the news conference the President gave today you would find in the answer to one of the questions toward the end of the conference he proposed a similiar idea….
10. Andrew
What is the future for sevitz.com?
11. Saltation
(actually the banking crisis was caused by uber-trusting wholesale people naively walking into a retail world of lies and deceit, which they’d never in their lives come across, and the result struck hard at a huge and violently fast system that balanced surreally precisely on a knife’s edge of counterbalanced forces/streams. kinda like pouring sand into an engine: 1950s cars cope fine and just run a little rougher, modern cars have four times the power and speed but achieved that by having all the tolerances pared to the bone, so a single grain of sand will screw the whole engine. )
the bank bailout actually DID include a bailout tax, and a very harsh one at that. so: good call.
it’s also worth pointing out that the bank bailout was not a Spend but an Investment, and all the bailingout governments have turned a VERY handsome profit on the investment. to be clear: the taxpayers have made a lot of money out of the bank bailout. (with the exception in the UK potentially of RBS, whose mgt is so screwed up they could still screw the bank up and lose the govt’s money)