Taxing bank size

The administration appears to be considering a tax on very big banks, or very interconnected banks, or both. There are three things to recommend that sort of a tax. First, it raises money. Second, it forces banks to pay for being big enough that the public will have to step in if they collapse. Third, it gives smaller, and thus less dangerous, banks a competitive advantage. The Economist explains:

A tax on size would seek to correct for the large negative externality associated with the systemic risk presented by too-big-to-fail banks. The larger a bank gets, the less likely the government is to allow it to fail, and the more shielded it is from potential losses. Size therefore generates some significant social costs, particularly since the negative externality encourages firms to take on too much risk. A tax on bank size would get firms to internalise the social cost.

And if banks were to pass the cost of the tax on to customers, that might not be such a bad thing, given that it would give a relative price boost to smaller banks. Consumers are notoriously reluctant to change banks, a fact which reduces the beneficial effect of competition. But as with a carbon tax, the effect of the levy would be to reduce bank size, regardless of who bears the cost of the tax. Even though size and connectedness aren't the be all and end all of systemic risk — leverage is key, as well — this kind of measure would be a positive step toward limiting systemic risk and moral hazard in the American banking system. And it would be another step toward a balanced budget. That's a lot to like.