The White House announced a levy plan that will tax big banks, insurance companies and broker-dealers for taking on too much risk and contributing to the financial crises. The plan is a fee that amounts to 0.15% on the difference between a big bank’s assets and the sum of its deposits and tier 1 capital (high quality capital such as common stocks and retained earnings). This difference includes the bank’s involvement in commercial papers and financial derivatives. The fee is called the “financial crisis responsibility fee”. The big banks and other financial firms are those institutions that have more than $50 billion in assets. There are about 50 of them in the United States. But the fee would fall the most on the nations’ six major banks: Citigroup Inc., J.P. Morgan, Bank of America Corp., Goldman Sachs Group, Morgan Stanley and Wells Fargo. Many of the financial firms have benefited from the $700 billion TARP money, particularly Citigroup and J. P. Morgan. Under this program, the US Treasury has given $247 billion to more than 700 banks and financial institutions, of which $162 billion have been paid back. Those institutions have also paid an additional $11billion in interest.

The White House has several justifications for taxing the big banks and other financial firms. The bailouts of those institutions have imposed significant costs on taxpayers and the economy as a whole and they should be paid back. They saved the banks during the financial crises and stabilized the markets they deal with. The tax can also be used as an instrument to get the banks to support regulatory reforms which are stumbling now. Finally, the tax can serve to rein in risk taking because it is imposed on involvements in financial derivatives.

The banks are now making windfall profits. They have benefited from the huge infusions they received and from the steepness of the yield curve. They pay low interest rates on deposits but they charge much higher rates on long term loans. The major financial firms are set to give record pays to their people for 2009. The top 38 banks and securities firms are on pace to award $148 billion to their executives, traders and managers for 2009 according to a Wall Street Journal’s study. 40% of profits in the economy come from the financial industry.

The tax plan started to have an impact. Some of the financial companies gave bonuses in stocks that can not be sold for several years. Others tied bonuses to performance. The tax will have a small impact on the companies’ profits. It is estimated to be 5% of this year’s profits. The impact will be less on the large regional banks than on the major Wall Street banks because of the difference in the composition of their balance sheets and the nature of the proposed fee. Still, the banks may revert back to their clever accounting engineering and shift many of the operations that will be subject to the tax to off balance sheets, increasing the financial risk and making banks more vulnerable to crisis. But the impact on banks will be muted if the bank fee is tax-deductible

The important impacts would likely be related to what will happen to lending, cost of capital, interest rates and the economic recovery. It will affect states’ economies disproportionately, with states relying on the financial services industry like New York will be affected the most.  Banks are threatening that they will reduce their lending and pass on the tax to consumers. If this happens, it will aggravate the lack-of-lending problem that exists now. Banks have accumulated excess reserves at the Fed and are satisfied by earning a small fee from the Fed on those reserves. If banks stop lending, as they have threatened, the Congress should impose another tax on excessive reserves to get the banks to lend and support regulatory reforms. In my opinion, the overall economic impact would be very modest. The $90 billion tax over ten years in a $14 trillion economy is a drop in the bucket.

Politically, the bank tax is worth more. There is a strong populist support among the American people to tax the big financial firms. Americans are dismayed and angered by the amount of profits these firms are making and the huge salaries and excessive bonuses they give to their executives. It will not be a surprise that Congress will pass the bank tax. It should be a great boost for President Obama whose popularity has been waning. It should also help democrats more than republicans who are becoming more confident in having another shot at the White House in 2013.