Taxing Big Banks for Being "Too Big to Fail"

After three years of work, last week Rep. Dave Camp (R-Mich.) put forward the proposed "Tax Reform Act of 2015." The first major tax reform proposal in years, the bill proposes major changes to the tax code for both individuals and companies. One of the many noteworthy proposed changes is a new tax on "systemically important financial institutions" for the implicit subsidy of being deemed "too big to fail." Read on for what was proposed, the companies that will be affected, and what it means for you.

Too big to fail
The basic idea of "too big to fail" is that the biggest banks in the world are now so large and interconnected that their collapse would be a disaster for the economy. The failure of one of them would be too much for the economy to handle, so the government would have to intervene. For those interested, Fool analyst John Maxfield wrote an interesting history last year of how banks became too big to fail.

With the passage of Dodd-Frank, regulators began deeming certain financial institutions with more than $50 billion in assets as systemically important financial institutions (SIFIs). This may have compounded the problem; many economists argue that banks benefit from their "too big to fail" status, as the market expects the government will step in if there are problems, and so gives them lower funding costs. Lawmakers have been trying to end this implicit subsidy, and the Tax Reform Act proposes a solution.

Excise tax on "too big to fail" financial institutions
The Tax Reform Act of 2015 proposes a quarterly excise tax of 0.035% on assets exceeding $500 billion for SIFIs. The stated reason for the tax is that "while tax reform cannot undo Dodd-Frank, it can and should help recapture a portion of that implicit subsidy." Overall, the Joint Commission on Taxation expects this would raise $86 billion over the next decade.

Who would be affected
The $500 billion in assets level is high enough that it would apply to just nine companies -- potentially 10 by 2015.

*MetLife is in the final stage of the SIFI designation process. Source: Federal Reserve, S&P Capital IQ, author's calculations.

As you can see, the tax would be a significant penalty on financial institutions that grow much beyond $500 billion in assets. It should be noted that this is just a proposal, and I'm sure the industry will fight this as hard as it can.

Will it pass?
In 2010, the Safe Banking Act tried to end "too big to fail" by setting up a number of regulations to cap banks based on size, sources of funding, and leverage. The bill failed to pass by 61-33, as many worried that more regulation and bureaucracy was not the answer to the problem.

I am optimistic that this excise tax will pass, as it is a simpler way to solve the problem of "too big to fail," and lawmakers seem up to it. On March 22, 2013, the Senate approved, by a unanimous vote of 99-0, a bipartisan amendment to the Senate budget resolution endorsing legislation to end subsidies and funding advantages received by "too big to fail" banks with total assets of more than $500 billion.

Bottom line
"Too big to fail" is still a growing problem that has only gotten worse since the financial crisis, and the excise tax on "too big to fail" looks like a good start to ending it.