Government Should Not Impose Windfall Profit Tax On Banks

By Author: Henry Ford
Total Articles: 189
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The government has proposed imposing windfall profit tax on bank that benefited form Trouble Assets Relief Program (TARP) funds, as a mitigating factor to respond to the recent economic crisis. The recent economic crisis has been described as the worst since the Great depression. Since 2007, economic meltdown, which started with the housing sector, spread to the whole economy and among the first casualties were the financial institutions. Most financial institutions were forced out of the market as customer faulted on their loans and inter-bank lending became difficult as most financial institutions were not willing to expose their financial status. The country was faced with an imminent collapse of the whole economy as most banks tightened lending and it became difficult to access loans from financial institutions. Most financial institutions were forced to merge and those which were not lucky were dissolved. The government moved in quickly. In order to save the troubled financial institutions from collapsing, the government instituted the Troubled Asset Relief Program (TARP) which would advance financial assistance to financial ...
... institution to strengthen their asset capital base. The program was initially scheduled to cost $356 billion but it ended up costing the government $89 billion. However, the financial package came with strict regulations since the government acquired stake in these institutions imposing various measures including regulation of executive pays and others. As the economic crisis settles, the government has proposed to impose windfall profit tax on those institutions as move to recover some of the public funds that were invested in TARP. Most of the institutions which benefited under TARP have been repaying back the amount they received to buy back the government stake and take charge of their operations again. Proponents of imposition of windfall profit tax on financial institutions argue that this would provide the government with addition revenue and redistribute it to the whole economy. However, as it can be learned through experience from earlier incidence of windfall profits tax on oil industry, windfall profit tax do not always meet the intended purpose. They are complex to administer and may have negative effect on the economy. The government should not impose windfall profit tax on financial institutions since this will hurt the recovering the economy.
Review of windfall profit tax
Windfall profit tax includes higher tax levied on profits, which ensues from a prompt windfall gain for a given industrial sector (Linda, 2004). This tax is levied on a given industry when the economic conditions improve to allow the industry to record above the normal profits. This tax is mostly levied to a targeted industry which has previously benefited from economic windfall in commodity or non-commodity based business (Thorndike, 2005). Through windfall tax, the government aims at getting more revenues which are then distributed to other sectors of the economy. Windfall tax has become a controversial issue every time the government institutes such measure because it is considered as an opportunistic move that is more likely to reduce the initiatives taken by the industry to seek profits. Windfall tax is also controversial in economic lens since excess profit in any industry should be reinvested to ensure that the industry can sail through during the time of crisis. Excess profits should be reinvested in order to promote innovation that is likely to promote the growth of the economy in other industrial sectors.
Windfall taxes were first instituted on the oil industry in 1980 when the government enacted the Crude Oil Windfall Profit Tax Act. This was taken as an agreement between the Carter administration the Congress to institute measures to decontrol crude oil prices (Lazzari, 2006). The main intention of this legislation was to recoup the excess revenues that had been earned by oil producers which resulted from sudden sharp price increase resulting from oil embargo imposed by OPEC. This tax act was instituted during to many factors which included:
The congress became increasingly concerned with the trend in world oil industry. It was concerned that the domestic oil industry was going to get enormous revenues and superfluous profits due to oil price deregulations which would allow the domestic producers to rest world price levels (Thorndike, 2005). Therefore, congress did not see it fit for the redistribution of income from consumers to few producers.
Congressional studies had made the congress believe that the industry was not paying fair share of taxes (Thorndike, 2005). The oil industry had contributed low income taxes to the government and this could be traced to two existing oil industry tax subsidies which included percentage depletion allowances and permits that allowed companies to expense intangible drilling costs.
The congress was also looking to increase government revenues in order to cover the deficits that had been experienced between 1961 and 1979. Congress postulated that windfall tax on oil industry would generate excess $393 billion (Lazzari, 2006).
However, the windfall act was repealed in 1988 during the low oil prices. It was replaced with The Omnibus Trade and competitiveness Act 1988. There were many factors which were considered by the congress in repealing the windfall tax and enacting The Omnibus trade and Competitiveness Act 1988. One of the main issues that had shaped the debate for repeal of this act was the fact that original revenue forecast had been overestimated, which in general reflected overestimation of the crude oil prices. In one decade between 1980 and 1990, windfall tax revenues generated 80% less than the amount that had been projected (Lazzari, 2006). This tax was also faulted on the grounds that it had increased national dependency on foreign oil since the tax was only imposed on domestic produced oil rather than the imported oil. Consequently, domestic oil producers increased their prices to cater for the tax and there was general increase in import of crude oil that did not attract the tax (Hargreaves, 2008). This tax also distorted distribution of resource in oil industry. The tax was imposed on drilling and therefore most investors shifted from exploration and drilling, which were taxed, to refining and marketing. The tax also proved very difficult to collect and administer. After the tax was repealed, it has been abolished and introduced by the congress a number of times. Once the oil industry makes superfluous profit, the government imposes windfall profit tax. For example, between 2007 and 2008, more than nine bills were introduced by the congress imposing tax on windfall profits.
It seems the government has not learned lesson about imposition of windfall profit from the oil industry. After the disastrous performance of the financial sector during the economic crisis, the government rescued the sector through TARP funds. Two years later, the government is proposing to impose windfall profit tax on these financial institutions when they show signs of recovery. The call to tax banker’s profit is unfortunate because the economy is just showing signs of recovery. The government is borrowing a leaf from Britain and France who plan to impose a 50 percent tax on banker bonuses (Harrop, 2010). From the experience with the oil industry, the government may be trending on dangerous path and this is a proposal that need to be shelved for the time being until such a time when the economy has fully recovered.
Why government should not impose windfall profit tax
The recent government proposal to impose windfall profit tax on financial institutions is misguided. In January 2010 the government released its “Financial Crisis Responsibility Fee” big bank tax which is expected to be rolled out in June (Recard, 2010). Government expects this windfall tax to contribute more than $90 billion in a period of 10 years and more than $117 billion in 12 years (Kroll, 2010). The government also asserted that taxing the big banks won’t go away until the TARP bailout money has been repaid to the full. This taxing will be applied to financial institutions that have more than $50 billion consolidated asset value including the bank holding companies like Goldman Sachs, thrifts, and insurance companies like AIG renamed Chartis (Beam, 2010). Interestingly, these taxes will not be imposed on Fannie Mae and Freddie Mac and the automakers. The taxes have therefore been motivated by the large profits these financial institutions have reported in the recent past. As analysts have point out, it shows a government that wants to stretch its muscles to almost all sectors of the economy and impose regulations that may hinder economic recovery. The fact that government assisted troubled financial institutions to recover from the impact of the economic crisis should not be used as a as excuse to regulate all bank operations. It is just two years since most of the financial institutions were granted funds to stabilize their operations. Although most of them have repaid back the funds they got from the government to buy their “freedom” from government regulations, the proposal to tax them may have long term impact on their stability and affect the rate of economic recovery. According to Republican National Committee Chairman, Mel Martinez, government proposed windfall profit tax is “The basis for [the bank tax] is populism. It’s very popular to whack the banks and talk about bonuses and get every dime paid back even though it’s already happening” (idebate.org, 2010) This means that planned government taxation system is based on the desire to create populism and to react to public feeling. It is mean to make the public feel that the government is addressing the wrongdoings that have placed the country in its current economic predicament but it has little merits in terms of potential benefits to the economy.

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