Bonus Question

What’s at stake: France on Thursday said it would follow Britain’s lead in levying a supertax on bankers’ bonuses, giving added momentum to efforts to curb high levels of financial sector pay. The British and French moves stirred the first real public debate as to whether the US should adopt a windfall tax, too. Sceptics call it “Old Testament” policies – in the sense that they punish the financial sector rather than fix structural problems, but there could be big gains from siding with Main Street against Wall Street. The US administration seems, however, anxious not to be seen as confiscatory and socialist.

Paul Krugman says Darling, I love you. OK, that’s way too strong. But Alistair Darling’s new super-tax on bank bonuses sounds like a good idea, on first read. Are we afraid that the best and the brightest will leave high finance and pursue other occupations? That strikes him as a good thing: everything we know suggests that the rapid growth in finance since 1980 has largely been a matter of rent-seeking, rather than true productivity. Or are we worried that it’s just unfair to discriminate against high-earning bankers? But, as Justin Fox points out, these are people who work at companies that probably would have ceased to exist if it hadn't been for government bailouts in the U.K. and U.S. More seriously, concludes Krugman, the whole sector has just been bailed out at immense taxpayer expense. Some payback seems entirely reasonable.

Models and Agents says that rather than going for the easy targets to appease a blood-thirsty audience, governments and journalists alike had better re-focus their efforts on policies that truly matter. Op-eds where ostensibly sober commentators are getting caught into the populist flow are a missed opportunity to inform the public about the fundamental problems in the financial sector (of which compensation is a by-product) and build support for policies to address them. Whatever the problems with bankers’ pay, they are the by-product of more fundamental problems in the financial sector as a whole: Inadequate risk-management and monitoring systems, unskilled (or complacent) and fragmented regulators and, possibly, a sub-optimal market structure.

Gary Becker says that the generous bonuses and stock options received by financial executives may often have been unwarranted, but they are being used as a scapegoat for other more crucial factors. The experience of other financial crashes also does not indicate that either the level or form of compensation of top financial executives were major factors in precipitating these crashes (Philippe Martin disagrees and quotes this recent paper from Princeton economists as a piece of evidence). Thousands of banks failed during the Great Depression, as did hundreds of American savings and loans institutions during the 1980s, without heads of these institutions in either case getting particularly high pay, or pay that was mainly in the form of bonuses and stock options.

Justin Fox says that the issue isn't the division of profits between employees and shareholders, it's the profits themselves. Shareholders are benefiting from this windfall in profits due to government intervention as much as employees are. So it's the windfall we ought to be yelling about. Not the bonuses. It is especially true for Goldman, as the timing and nature of the rescue worked very much to Goldman's benefit, by wiping out competitors while leaving Goldman standing.

Buttonwood’s notebook says that the likes of RBS and Lloyds – now majority-owned by the state – are different from Goldman Sachs and J P Morgan. We have the right to interfere in the first two. Yes, the latter have benefited from implicit government support, zero rates and the rest. But so have property companies, retailers, car manufacturers and quite a few others.

FT Money Supply says if policymakers do not act to address the public’s justified anger there will be long term costs. People have lost faith in economic institutions such as the Fed and Treasury because they believe these institutions are working in the interest of Wall Street rather than the general public. The best way to lance the boil is to recoup the value created by taxpayer-backed interventions through a windfall tax. Having imposed a windfall tax the Treasury and the Fed would be in a better position to resist bad policies e.g. punitively high rates of tax on high earners on an ongoing basis.

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