How to tax the bankers

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This, by me, is on the Guardian’s Comment is Free this afternoon:

Rumour has it that Alistair Darling is about to introduce a windfall tax on banks, and bankers. It's an idea that, as Larry Elliott has noted, is timely and appropriate. It is also fraught with problems if the action is to match the rhetoric. And let's be clear: this is important. Tax is not just about revenue raising: tax is also about pricing unacceptable behaviour out of the market and redistributing income and wealth — especially wealth considered by many to be unearned.

I have been arguing since 2007 that UK banks should pay 10% more in tax than other companies. I argued at that time that this was the fee they owed for the state taking the risk of guaranteeing the deposits on which all banks (without exception) depend. That guarantee is still in place. It is why we, the ordinary people of the UK, bear the risk of banking now, for which we need to be compensated by way of additional tax payment.

The tax due would be significant. Between them HSBC, RBS, Barclays, HBOS and Lloyds TSB declared current UK tax liabilities of £6.5bn in 2006, the last year before this crisis began. This was tax due at 30% at the time. At 40% they'd have paid almost £8.7bn. That's an extra £2.2bn of tax they'd have paid in the UK. Which as a fee for the deposits protected is insignificant, but if it had been introduced when I called for it in 2007 it might have had the required sobering effect that could have helped prevent the disaster of 2008. That is why such a tax is due now, and would, I think get EU approval, even after rigorous anti-avoidance rules to stop profit being shifted abroad were put in place.

And what of bankers' bonuses? Three practical responses are needed. First, as both Compass and the TUC have demanded, rigorous measures to stop tax avoidance by the very highest income earners in the UK are needed if any measure to tackle bonuses is to be effective or most of any additional tax charge will simply be sheltered using loopholes. As both organisations note, this is possible.

Second, it has to be said that tackling bonuses alone is going to be hard. True, if they are paid in shares that may make the task easier — but we are already hearing about massive basic pay rises to get round these constraints. And because we have yet to even see the 50% tax rate in operation it is hard to see how a rate above that could be introduced at present. This therefore requires creative thinking and I have two suggestions.

The first is very effective. It is to simply say that no bank (and they are easy to identify as they have to be licensed to operate in the UK) will get tax relief on paying a salary of more than £250,000 a year. This may not seem to hit the banker, but it will. Assuming a banker has basic pay of £250,000 and a bonus of £1m then that bonus would cost, assuming the banker was in a company pension scheme, almost £1.1m (if it was itself non-pensionable) and after 40% tax and 1% national insurance the banker would get about £590,000 (all numbers rounded for ease). At 28% corporation tax (the rate now due) tax relief would amount to a saving of just over £300,000 to the bank paying this, making its net cost of the bonus about £800,000.

If the bank wants to spend the same money on the bonus — £1.1m, then it can now only spend £860,000 because the difference (£240,000) would now have to be used to pay corporation tax. After employer's national insurance a pot of £860,000 pays an actual bonus of about £780,000 on which tax and national insurance will now (at 41% combined) be about £320,000 leaving a net benefit of £460,000.

That then leaves room for the last recommendation though, to increase national insurance rates on salaries over £250,000 (and ideally somewhat lower sums as well) so that this rate on such salaries is 11% — as it already is on salaries of £25,000. In that case the total tax paid on the new bonus would be about £398,000, leaving a bonus left after tax of £382,000.

That is still a staggering amount of money for anyone to receive after tax in a year. But more than £200,000 of additional tax would have been paid on this sum and tax relief of some £300,000 saved meaning, in effect, at least £500,000 extra to the Treasury on such a payment.

Two things inevitably follow: the Treasury will be better off, and bankers' bonuses will be reduced. Both are good news. And let no one cry for the banker: they're still getting a cash bonus well over 15 times bigger than UK average gross pay, which must, given that the example is entirely realistic, be a reason for creating the high pay commission so many now demand for the UK.