TAX NEWS - 2010

Bank Tax: Fed's Kocherlakota Renews Call for Bank Tax to Curb Bailouts

Narayana Kocherlakota, the Federal Reserve's newest policy maker, renewed his call for a tax on financial firms to limit future bailouts, while criticizing the Group of 20's recommendation for higher capital requirements.

"Knowing bailouts are inevitable, financial institutions fail to internalize all the risks that their investment decisions impose on society," he said in the text of a speech today in Montreal, similar to one given in May. "Taxes are a good response because they create incentives for firms to internalize the costs that would otherwise be external."

The remarks put Kocherlakota, head of the Minneapolis Fed, closer than any other Fed official to the positions taken by the Obama administration and International Monetary Fund. While the idea of a global levy is backed by France, Germany, the U.K. and the U.S., the G-20 countries ended their June 26-27 summit in Toronto without agreeing to such a measure.

"A financial firm should be taxed for the amount of risk it creates that is borne by taxpayers," based on the government's estimated, discounted cost of a bailout in the next one to 30 years, Kocherlakota said.

Comparing banks' risk-taking to the air pollution caused by factories, he said the solution "is to regulate the amount of pollution" rather than "how the firm creates it."

The G-20's June 27 statement suggesting banks hold more capital "strikes me as too weak," Kocherlakota, 46, said during the Society for Economic Dynamics Annual Meeting.


'Forward-Looking'

"It seems to me that capital and liquidity requirements are intrinsically backwards-looking," he said. "We need forward-looking instruments for what is intrinsically a forward- looking problem. And that's a key reason why taxes, based on market information, will work better."

At their most recent meeting in June, Fed officials retained a pledge to keep the benchmark interest rate at a record low for an "extended period," saying that "financial conditions have become less supportive of economic growth on balance."

Kocherlakota, who has led the Minneapolis Fed since October, did not comment on the future path of monetary policy. He will be voting member of the committee next year.

Earlier this year, the White House asked Congress for a tax on firms with more than $50 billion in assets to recoup the costs of the Troubled Asset Relief Program.