Swedish financial tax: the hypocrisy

The previous article explained the possible effects from the financial tax the Government of Sweden intends to impose. Here follows a perspective on the solution.

Unless the motivation from the Government’s perspective is to relocate Swedish bankers to foreign countries, so that housing will be freed up for refugees, the two objectives mentioned in the previous article remain: (1) reduce private consumption of financial products, of which loans represents a majority, and (2) increased tax revenue. It's then a paradox that politicians subsidise private lending through interest rate deductions. It would seem more natural to reduce the tax deduction from interest rates for private households. This way the private consumption of financial services and products would be targeted specifically without all side effects. Of course, this may not be a popular move politically. It appears more popular to punish the highly profitable banks. Given the history, banks can expect no sympathy or praise for making money. Rhetoric such as “the banks can afford it” has become an effective way to improve the polls. The financial tax may resonate with the government’s left wing voters, and may seem like a reasonable political move. Given that they are willing to go into history as spearheading the effort of another failed Swedish financial tax.

The hypocrisy of the proposed financial tax is that the Government selectively choses effects from the two aforementioned scenarios at their own convenience - and pretends to be the white knight while in truth fooling everyone. The academic arguments used in support of the tax are only valid in scenario 1, where the tax leads to higher prices and does not impact wages or bank profits. At the same time, Government officials use arguments of the likes that banks can afford it or earn too much, which are based on scenario 2 pertaining to reduced salaries or bank profits. Is the government supporting effects they know to be damaging for the economy and society, and that they don’t believe in, just to attract voters and gain popularity? Or is it a warning sign that the Government does not believe in the scenario from which the proposal was based? The latter would leave no academic rationale for the tax in support of benefits for the Swedish society. But why would politicians care? As long as it helps balancing the budget in the short run, and their indebted voters remain fooled, the political cost is probably found to be less than the alternatives. After all, isn’t that what matters most for their personal gain? For the Swedish society, on the other hand, this type of behaviour is undermining the future of the democracy and welfare state.

Just another symptom of the underlying disease

The actual disease of financial industry is of similar nature to that of politics - misaligned incentive structure. The disease of financial industry is moral hazard - incentivising excessive risk taking. In politics, the disease is populistic myopia - the inherent incentive to promote policies to win voters instead of policies to improve the economy, environment and society long term. In the same fashion that bankers may have exploited the incompetence of its customers, democracy allows for the exploitation of incompetent voters.

Without correcting the root-cause problem - moral hazard - policy makers are imposing increasingly strict regulation on the banks in an attempt to prevent excessive risk taking and promote financial stability. This has indeed treated the symptom of excessive leverage, but as with any symptom kept in check with pharmaceutical drugs without correcting the root-cause; side-effects will accumulate. The trend of regulation has been fuelled by the popularity of punishing the evil banks after the financial crisis. Ironically, these regulations play to the big banks' advantage by creating barriers to entry and a potential for economies of scale. The result is fewer and bigger banks while also mitigating the competition from fintech companies. This leads to less competition and bigger margins. The too big to fail banks are even bigger than before the financial crisis. The wealth-gap is higher than ever. These are the side-effects of the medicine prescribed by politicians. The bank profits politicians attempt to claim through taxes are of the politicians own making.

Taxing salaries to reduce the banks' profits is a short-sighted solution to increased tax revenue - or lower bank profits. To the extent that high bank profits are structural, it must be in the absence of fair competition. This is where policy makers still have a long way to go, since focus is on bug fixing and workarounds rather than system design. After all, that's what gets them elected. But when the bugs get out of control, it can be a sign of bad system design with too many workarounds on top. And with regards to workarounds, it seems policy-makers have been bitten by the bug.

Before politicians can be expected to prescribe the right medicine to moral hazard, they must be treated for their own disease. A politician with the wrong incentives may create more problems than she solves. Any doctor can spot the symptoms, but it requires a skilled and virtuous doctor to come up with the right diagnose and appropriate treatment. Regardless of whether it´s the patient or doctor that needs treatment first, a better doctor is sought after.

#VAT #Swedishfinancialtax #Misalignedincentives #moralhazard #populisticmyopia #Populism

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