The Bank Basher’s Dilemma

Populists may have to choose between taming banks and taxing them

Senator Elizabeth Warren

Senator Elizabeth Warren

The victory of the left-wing Bill De Blasio in the New York Mayoral election has led to a considerable interest in the increasingly populist direction of the Democratic Party. One well respected journalist has gone as far as arguing that the anti-Wall Street crusader Elizabeth Warren might be the next president.

has identified a problem with this movement. Essentially, he identifies two objectives it has. First, of all it wants to reign in the behaviour and size of large financial institutions. Secondly, it wants increases in public spending funded by higher taxes on the financial sector and the super wealthy (who typically work in finance). These two objectives seem of a piece but as Yglesias explains they are actually contradictory:

Suppose that President Warren rides to town with a raft of new legislation and tough regulators and a set of U.S. attorneys firmly dedicated to prosecuting financial wrongdoing with the utmost rigor. Well if it works, the pretax income of Wall Street types is going to plummet. And while that might well be good for the country and the middle class broadly, it would cause the tax base in New York and California and other politically blue high-inequality jurisdictions to fall. Rather than hiking rates on the rich to pay for new programs and more generous wages, these places would find themselves either needing to tax the middle class (a much tougher sell politically) or else shift into a neoliberal efficiency-seeking mode. By contrast the Tim Geithner philosophy—regulate Wall Street but don’t seek to transform it or displace the sector from its leading role in America’s political economy—is a great match for the politics of progressive taxation to finance public-sector social democracy.

Which is to say that the alliance between labor unions and bank bashing is a very effective and powerful one as long as it doesn’t actually win. A big-city mayor doesn’t have the authority to crack down on Wall Street, so he or she is ideally positioned to tap the rhetoric of bank bashing in service of an agenda of progressive taxes and high spending. But a president really could take on the fat cats—not just taxing them but making their underlying businesses less lucrative, leaving less in the way of tax revenue to scoop up.

This is a dilemma that plays out in British politics too. Take the issue of a financial transaction tax. The main campaign group that promotes it does so as a revenue raising measure: “Robin Hood supporters believe that banks, hedge funds and the rest of the financial sector should pay their fair share to clear up the mess they helped create.” But that would shrink the financial sector, which would reduce the income, corporation and other taxes it pays. However, it would have the welcome effect of cutting down banking’s oversized role in the economy.

Given that there is a tension between the two policies, I’m inclined to make rebalancing the economy the priority. Cradling the financial sectors while using the tax revenues it generated to expand the welfare state was essentially what the last Labour government did and that didn’t end well. Not only does it squeeze the real economy but it also ties the public finances to the fluctuating fortunes of the City. In short, it’s an anti-austerity proposals that risks creating a requirement for austerity next time the banks run into trouble and start paying less tax.

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