Analysis: Policy is incoherent and potentially dangerous

Published on 08/02/2011 17:31

THE government's policy on the banking levy is incoherent. According to the Treasury, the levy is designed to ensure banks pay the social costs of their failure: in other words, the levy should compensate taxpayers for the cost of bailouts.

This may seem reasonable at first sight - especially if the levy were related to the risks that banks take. However, the government has also established an Independent Commission on Banking, which it expects to provide better legal frameworks for banks so they can go bust at no cost to the taxpayer. In other words, it is firm government policy that the very problem at which the levy is aimed will be resolved in the near future.

I am particularly suspicious of the announcement being made yesterday. The government is taking a lot of unjustified flak for not taxing bankers' bonuses. It has reacted by announcing an increase in the bank levy for this year and pledging to make the levy permanent. The justification is weak - the government is saying the banks are better capitalised and can afford to pay. However, if they are better capitalised, they are less risky and, therefore, the levy is more difficult to justify. But I think we see the underlying reason when we hear the Chancellor say the revenue is just going into general government coffers to help reduce government borrowing.

This is not the only area where policy in relation to the financial sector is incoherent. We have the government telling banks to hold more capital against their existing lending to reduce risk; yet, at the same time, government is twisting banks' arms to increase levels of risky lending to businesses.

Such measures just add to the feeling the government is using financial services as a political football. This is a dangerous game. The sector had a net trade balance of 42 billion in 2009. In the language of economists, this sector is where our comparative advantage lies. We export financial services and use the money to import goods and services made more cheaply abroad. It is not just the level of taxes, levies and regulation that will make financial institutions nervous: the business uncertainty the Chancellor is creating could be deeply damaging. Many banking and other financial services could be produced in other countries with more benign regimes.

The government needs to take a step back, pause for thought and think strategically. If the Independent Commission on Banking comes up with coherent proposals that will allow banks to fail at no cost to the taxpayer, little else needs to be done. The government can put away its big sticks and stop playing silly rhetorical games.

• Professor Philip Booth is editorial and programme director at the Institute of Economic Affairs.