Taxing the “bad guys” who caused the global financial meltdown may be popular, but would it work?

By  Coletta Kemper

My economics teacher always preached “tax the polluter.” But politicians worldwide are finding that this strategy is easier said than done. As governments struggle to dig their economies out of enormous debt while heading off future financial calamities, they are looking for answers to some tough questions. How do you pay for the bailouts, punish the “bad” guys and deter future risky behavior while avoiding a drag on economic recovery?

The International Monetary Fund (IMF) pegged the cost of cleaning up the financial crisis for the G-20 countries at a stunning $13.6 trillion, contributing to an average overall deficit of 6.9% of GDP for this year, compared with 1% in 2007, before the crisis. The cost of pumping money into banks to prevent collapse, buying up “toxic” assets as well as debt, and providing liquidity guarantee support, added up to more than a fifth of the world’s total annual economic outputfor 2008. Most of the repair bill comes from developed countries, which are anteing up about $11.9 trillion of the total.The other $1.7 trillion falls on developing nations.

Those numbers don’t include other costs, such as business failures, the slowdown in economic trade and declines in consumer wealth worldwide. What the final tab will be for the crisis is anyone’s guess.

The idea of taxing the wrongdoers has public appeal. But what some see as just punishment for the polluter, in this case the financial system, others see as a Robin Hood tax—steal from the rich to give to the poor. Nevertheless, the concept caught on when earlier this year President Obama proposed a levy on financial institutions to discourage risky behavior and build an insolvency fund to bail out failing banks in the future. At the time, his European colleagues applauded his bold initiative. Since then, a number of controversial tax proposals have been introduced to mixed reviews.

Last spring, the IMF called for countries to impose taxes on the financial sector aimed at building a fund to pay for a future crisis and curbing excessive risk by financial institutions that could lead to another fiscal calamity. The IMF estimated that a “financial stability contribution” tax could raise about 2% of a country’s economic output. In U.S. terms, that’s about $300 billion in a fund to pay for future bailouts. Another tax is aimed at discouraging risky behavior and decisions.

It’s no wonder the politicians’ eyes lit up on the prospect of all that cash coming into their depleted treasuries.

In June, 27 members of the European Union agreed on a tax on banks that would pay for future bailouts and could net $67 billion for EU members. In adopting the plan, the European Commission said the levy on banks would ensure that taxpayers didn’t pay for bank failures. It agreed that member states would introduce their own taxes, which Sweden, Britain and Hungary have done. But some members are concerned that a tax could undermine recovery.

Despite opposition from the IMF and the EU, Hungary’s legislature passed an onerous tax on financial institutions, which is three times larger than taxes proposed elsewhere in Europe.

Banks and the insurance industry also opposed the tax. Insurers argued they were not responsible for the fiscal meltdown.

Another EU proposal to tax all global bank transactions was dead on arrival at the June G-20 meeting. Although the tax had the support of the IMF, European Union officials and the U.S., it was opposed by nations with relatively strong banking systems, such as Australia and Canada, as well as Brazil and India. They argued that the levy would hurt banks that did no harm to the economy.

President Obama’s bank tax met a similar fate in the final hours before Congress approved a sweeping financial reform bill in July. To get the votes needed to pass the bill, a $19 billion tax on banks and hedge funds was stripped from the legislation. In its place, Congress opted to end the TARP bailout program early and use about $11 billion for a future rescue fund. Large banks will also pay a fee to the Federal Deposit Insurance Corp., which protects individuals’ money deposited in FDIC-covered banks.

But the big banks aren’t off the hook yet. When signing the historic legislation July 21, President Obama promised “no more taxpayer financial bailouts.” The challenge is to figure out how to do that. The bill calls for a study of whether “too-big-to fail” banks should be required to issue debt that converts into equity during an economic crisis.

Although the global bank tax is dead with the G-20 for now, it may be resuscitated in the months ahead if other ideas to protect the global banking system aren’t found. Two things are certain: death and taxes.

Kemper is The Council’s vice president of Industry Affairs.