TAX NEWS - JUNE 2010

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Canada Tax: Why you don't want a tax on your bank

Don't know if you saw the little item on CBC's The National last week about the Bank of Canada's decision to raise interest rates and the chartered banks' following suit. Then right afterward came a note on how the big banks are doing, profit-wise. The Bank of Nova Scotia had the misfortune of announcing its quarterly profits the same day: a record $1.1 billion. Implicit editorial message: The banks keep on ripping us off. The National may feature the often market-friendly commentary of Rex Murphy and Andrew Coyne, but the news coverage is dependably mistrustful of capitalism.

Quoting the dollar value of bank profits is typical of the brain-free approach to banks taken by most of the country's media and -- who knows? -- citizens, too. The Financial Post 500, which came out last week, reveals that last year the Bank of Nova Scotia had assets of $497 billion. Last year's profit -- $3.5 billion -- thus represented a return of just 0.7 per cent on those assets. The Royal Bank's return on assets was 0.6 per cent, the CIBC's 0.3 per cent, TD Bank's 0.6 per cent. True, because shareholders' investments finance only a fraction of the typical bank's assets, rates of return on "equity" were much higher than that -- 15.3 per cent for the Bank of Nova Scotia -- but the point remains: The banks are hardly as rapacious as the absolute-dollar numbers suggest.

No matter. Apart from BP-bashing, nothing is more satisfying these days than dumping on financiers generally and bankers in particular. (Great New Yorker cartoon this week: A TV anchor intoning: "The market hit new highs today, while the contrition index remained at zero.") Populist fury presumably will only grow with news that after resistance from Canada, Japan and Brazil the G20 finance ministers will not be recommending an international bank tax, after all.

Who would have paid such a tax? The brain-free view is "bankers." Tax them appropriately and they'll have to fire their chauffeurs and drive Chevies, sell their corporate jets and fly commercial, unload their Muskoka cottages at fire-sale prices, trade in their bespoke French-cuffed shirts for Sears specials and move their corporate headquarters from those shining towers on Bay Street to strip malls in Mississauga. The green-eyed monster that is egalitarianism would be mollified -- though concern might arise for the fate of the chauffeurs, pilots, tailors and cottage-maintenance folk. Such concern would be the beginning of wisdom.

Consider the complete repercussions. If you tax bank executives at politically satisfying, i.e., extortionary, rates, but don't also tax executives in all other sectors, you'll soon observe a shortage of capable bank CEOs: Unrestricted free agents all, they'll find work elsewhere. Who will run the banks? Pay a half million a year and thousands of people will volunteer. But perhaps not many you'd want to entrust a half trillion dollars or 67,802 employees (in the case of the Bank of Nova Scotia) to.

The same with a tax on bank profits: Hike the tax rate aggressively and bank stocks will plunge pleasingly. Trouble is, as the FP 500 makes clear, our major banks are widely held. The homeless probably don't have many shares. But anyone with a pension plan almost certainly does, and many more people beyond that.

Will the banks respond to a new tax with business as usual? If they're going to continue to attract capital -- that is, persuade people to buy their stock -- they have to offer a competitive return on equity. Put a big tax on their profits and they'll have to earn even higher pre-tax profits in order to hit a given level of after-tax profits, which is all that matters to investors.

How do the banks hike their pre-tax profits? By being more selective in their lending and channelling money only to the better class of investors. By raising their "spread" -- the difference between the interest rate they pay depositors and the rate they charge lenders. By raising their ever-popular service charges. By being less generous to their employees -- all their employees, not just those who drive Mercedes. And so on.

It's even possible that if the bank tax is high enough, some banks -- probably not many and maybe not the biggest ones but almost certainly more than none -- may decide they can't really make a go of it. In which case, the country that got through the Great Recession without losing a bank won't get through the aftermath unscathed.

Banks don't pay taxes. People do. Aim at the banks if that makes you feel good but be at least a little thoughtful about whom you'll really hit.
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