Numbers that the Americans are debating include a levy at 0.15% for 10 years on all financial institutions with more than $50 billion in consolidated assets.

With Germany and England ready to take action and implement similar levies, and with Obama seeking to push the US to do the same, it’s unclear what kind of overall effect these levies would have on banking if they are carried out on a piecemeal, domestic basis. These financial institutions are international in character. Their activities transcend national borders, and thus any attempt at regulation will need to account for the cross-border transactions and international nature of the institutions. Will domestic regulation really solve the inherent problem of big banks making big investments without thinking about the potentially big (and devastating) consequences?  Probably not.  So then what’s the point?

Edwin M. Truman, Senior Fellow at the Peterson Institution for International Economics in Washington, proposes a different analysis. He says, “There are two dimensions — paying for the past and paying for the future.”  Instead of seeing the tax as a sure-fire way to implement reform in the banking industry, he would see it as a way for governments to recoup their bailout cash and to provide a cushion for future bailouts.

One other contentious factor in the taxing of banks is the worry that levies will create further competition for banking jurisdictions. While when it comes to corporations law, Roberta Romano has deemed this competition for jurisdiction the genius of American corporate law, it is not clear that there is a direct parallel for the banking sector. For a financial institution, its bottom line may more readily be finding the jurisdiction with the lowest tax, as opposed to a jurisdiction with great legal experience in banking affairs. Starting competition between major governments as to who could offer the lowest levy won’t address the major internal reforms sought for the entire banking system.  Banks are also usually backed by some kind of governmental guarantee (at least to a certain amount), which complicates a government’s interest in hosting a foreign bank seeking to evade that nation’s bank levies.

So what can these levies do so long as there is no unified global approach? The answer is, in short, insurance.

In the case of Sweden, the insurance role of the levy  funded by those financial institutions creating the risks is clear.  According to measures adopted late last year, the government plans to raise roughly 2.5% of the GDP in the form of bank levies over the next 15 years. The annual levies begin at 0.018% of the institution’s liabilities (equity capital and some junior debt securities excepted.) Starting in 2011, the levies will rise to 0.036%. Sweden has based these numbers on what they project a potential future banking crisis would cost. As such, money collected under these taxes is allocated into a stability fund. If a future crisis were to arise, bailouts would come from this fund and not from the public purse.

Meanwhile, the world awaits to see if there will be a global reaction to these proposed levies. All eyes will be on the G-20 meetings in Washington later this month when the IMF delivers a report on bank levies.  While it still remains a contentious matter, there may still be hope for a more unified approach in order to revolutionize responsibility undertaken by financial institutions.

The idea was subsequently picked up by UK PM Gordon Brown and presented to the G20 at their meeting in St Andrews, Scotland on Nov 7th.  Brown presented the tax as an instrument to fund future bank bailouts.  Moreover, he sees the tax as increasing accountability in the financial sector.   However, the idea was not received as well as had been hoped.  The USA has rejected the idea, and Canadian Finance Minister Jim Flaherty also came out against the tax.

While things looked dismal for the tax proposal following the G20, it seems that at least as far as the US is concerned, the idea in principle may still be kicking around Congress.  U.S. House of Representatives Speaker Nancy Pelosi has spoken out in favor of a similar proposal, affectionately named the Wall Street tax, from which funds would be used for job-creating legislation sought to be passed in December.  The Democratic proposals are citing nearly a $150 billion per year fund to help with economic recovery. However, the US is staunch about the necessity of the tax being an international one, otherwise it stands the risk of losing financial jobs to markets overseas.

So what would these taxes practically look like? Democrat Representative John Larson proposes a 0.25 percent tax on over-the-counter (OTC) derivatives transactions.  But once again, we see the Democrats in favour of the tax being adamant about applying this potential tax internationally.  These OTC derivative transactions go on primarily between banking and financial institutions and include interest rate contracts, credit default swaps, foreign exchange contracts, commodity contracts and equity contracts among others.    To contrast, France was looking at roughly 5 cents on every 1,000 euros.

As long as the US dollar remains as a standard trading currency, there is an opportunity to achieve the goals set out by this potential tax proposed by some Democrats.  Even when money is traded in US dollars between two foreign banks, the transaction passes through New York.  However, a potential tax only on USD transactions thus would tally another minus for the already weakening use of the USD as a currency of trade.

However, it leaves one to wonder how feasible a truly solidified global financial tax really is.  While places like New York and London have been seats of financial power for ages, there’s no telling what might happen if the tax isn’t uniformly implemented.  All it takes is one or two countries with a relatively stable currency to withhold to cause a great threat to the goals of the tax.  The danger is not just in the abandoning of the US dollar as a currency of trade, but rather corporations moving operations overseas.  Like the phenomenon of ships leaving the US to be registered under Flags of Convenience, a non-uniform global tax might cause corporations to do the same.  And that certainly wouldn’t help raise funds for stability or any future bank bailouts, nor would it help create more jobs in this continued time of high unemployment.

As we are all well aware, the international credit crisis, which came to the fore in 2008, resulted in the collapse or near-collapse of financial institutions and sources of credit for businesses around the world – causing trade levels, investment and global output to plummet, and thousands of jobs to disappear. In the fall of 2008, there were fears that a depression similar in intensity to the Great Depression of the 1930s was looming. In response, many states announced significant injections of capital into troubled financial institutions and industrial sectors to avoid their collapse, and to facilitate access to credit by industry. They also adopted measures to stimulate domestic demand.

Global leaders, particularly those representing the G20 group of countries, also moved to take a coordinated approach to the crisis. The G20 leaders first met in November 2008 for a Summit on Financial Markets and the World Economy, where they issued a Declaration in which they promised to “work together to restore global growth and achieve needed reforms in the world’s financial systems”.[3] As part of this declaration, the G20 leaders made four trade-related commitments:

1. To refrain from raising new barriers to investment or to trade in goods and services, imposing new export restrictions, or implementing WTO-inconsistent measures to stimulate exports.
2. To minimize any negative impact on trade and investment of our domestic policy actions, including fiscal policy and action in support of the financial sector.
3. To notify promptly the WTO of any such measures; and
4. To call upon the WTO, together with the Organization for Economic Cooperation and Development (OECD) and the United Nations Conference on Trade and Development (UNCTAD) to monitor and report on their adherence to these undertakings.

In late September, the WTO, the OECD, and UNCTAD released their second report on the G20 countries’ adherence to these undertakings: Report on G20 Trade and Investment Measures.[4] The report identifies approximately 280 measures undertaken by G20 countries between April and September. The report expressly reserves opinion as to the legality of the measures under WTO rules, or their trade-distorting nature. While the authors did not find “widespread” resort to trade and investment restrictions as yet, they did find “policy slippage” and pointed to multiple examples of protectionist measures adopted by G20 members, including agricultural export subsidies, tariff increases, new non-tariff measures, and trade defence mechanisms.[5]

In June 2008, the UK-based Centre for Economic Policy Research launched Global Trade Alert (GTA), a service providing real time information on state measures taken during the current global economic downturn that are likely to discriminate against foreign commerce. The GTA also issued a report shortly before the G20 meeting in September with its own analysis of the extent to which the G20 has “kept its promises” to avoid protectionism. The report, Broken Promises: a G-20 Summit Report by Global Trade Alert, identifies over 400 trade-related, state initiatives undertaken in the wake of the crisis.[6] It distinguishes between three types of measures:  those that almost certainly discriminate against foreign commercial interests; those that may discriminate against foreign commercial interests; and those that are either non-discriminatory or involve liberalization.[7] The study finds that “the overwhelming picture is one of planned and implemented state initiatives that reduce foreign commercial opportunities and reverse the 25-year trend towards open borders.” It estimates that worldwide, the number of discriminatory measures being implemented outnumbers the liberalizing measures by five to one.[8] The GTA finds that the impact of these measures is cause for significant concern: fewer than 5 percent of product categories, 20 percent of economic sectors, and a small number of trading jurisdictions have not been affected by any significantly restrictive measures.[9]

The two reports offer slightly different views as to the current intensity of trade protectionism. However, they are in agreement that the main challenge associated with the current protectionist mindset is the fact that many more protectionist measures are ‘in the pipeline’- planned and approved, but not yet implemented. They both stress that the main risk to the trading system is that states will continue to cede to protectionist pressures. Both caution that the continued implementation of protectionist measures will further erode trade liberalization achievements, and, more importantly, will hamper the global economic recovery. Both urgently recommend that governments plan a coordinated exit strategy to eliminate these elements as soon as possible.

The G20 leaders have announced their intention to prepare exit strategies.[10] However, they have merely agreed to implementation “when the time is right”. In light of the many trade protectionist measures still in the pipeline, their failure to commit to a timeline could contribute to aggravating the contraction of world trade and investment, which would undermine confidence in an early and sustained recovery of global economic activity. Stronger action is required.

[2] G20 Summit Declaration, “The Global Plan for Recovery and Reform”, London, 2 April 2009.  Accessed online October 25, 2009 at http://www.g20.org/Documents/g20_summit_declaration.pdf.

[3] Ibid.

[4] Report on G20 Trade and Investment Measures, September 2009. Accessed online October 25: http://www.pittsburghsummit.gov/documents/organization/129863.pdf.

[5] Ibid, at page 6.

[6] Simon J. Evenett (ed), Centre for Economic Policy Research, 2009. Accessed online October 25:  http://www.globaltradealert.org/sites/default/files/Broken_promises_GTA_second_report.pdf.

[7] Ibid, at page 18.

[8] Idem, at page 13.

[9] Idem, at page 4.

[10] http://www.g20.org/Documents/pittsburgh_summit_leaders_statement_250909.pdf.