Taxing the rich is harder than you think, part 2

A few weeks ago, I wrote this on the effectiveness of introducing a tax surcharge on high income earners as a way to reduce income inequality:

[We] have to look at the incidence of the increased tax on high earners. The burden of the tax does not necessarily fall on the people who actually pay the tax.

We can be pretty sure that if there's one group of people who won't be paying the tax, it is the high-income earners themselves...

[T]he gross incomes of high-income earners will rise so that their after-tax incomes are the same. Extra revenues will be generated, but the burden of the tax increase will be borne by those below the top end of the income distribution...

The tax system is at best a clumsy instrument for redistributing income, and there are simply too many possibilities for generating unintended perverse outcomes.

Soon after, the UK government announced a tax of 50% on bank bonuses. And today, we have this (h/t MR):

Bankers escape bonus blow: City bankers will suffer little or no impact from the bonus supertax imposed by the government last month, according to a Financial Times poll of leading investment banks.

Most banks, polled in an anonymised survey, said they would absorb all or part of the cost of the one-off 50 per cent tax by inflating their bonus pools, even at the risk of irritating the government and their own shareholders.

The results chime with intelligence garnered by headhunters. “The tax is going to be 90 per cent absorbed by the banks,” said one senior recruitment consultant with clients in the City.

So just who will end up paying that surtax?

Comments

[Just visiting from macleans]

Given that it's a "one-off 50 per cent tax", I'd say the shareholders.

[Christopher Hylarides]

The UK also raised the top income tax rate from 40% to 45%.

Who's going to pay for that? My guess is the people that would have had jobs on the money they would have spent or invested. :-/

[Zephyr]

Taxes are a cost of doing business. They are factored into the pricing and ultimately passed on to the consumers.

[Curmudgeon]

The problem here isn't taxation but rather pricing power. That the UK banking industry has the pricing power to force its customers and shareholders to eat a 50% tax increase is a serious problem in its own right and is something that needs to be dealt with along side excessive compensation.

Adequate corporate governance structures would prevent management from writing itself 50% pay increases at shareholders' expense. Preventing banks from squeezing customers is somewhat harder without utility-style regulation.

Addressing compensation theft by the rich isn't just a matter of taxation but it's certainly not an impossible problem.

[Just visiting from macleans]

How do investment banks pass on the costs to their customers? Cheaper wine at dinner? They're not exactly Walmarts.

This to me appears to be a one time political slap on the wrist for the financial crisis, and the bailouts that ensued (while maintaining healthy bonuses). If the punitive tax was longer term, perhaps the investment banks' most profitable and competitive sectors would locate elsewhere, but still maintain a local presence, though diminished.

[Doc merlin]

"So just who will end up paying that surtax?"

Consumers always end up paying the taxes, companies just pass them off, thats always and forever the way it works. In this case it will probably be effectively amortized over time.

In this case, because of the extremely mobile (and mercenary) nature of high level bank employees (and because of the new mobility created by the ECC/EU) if the bank didn't absorb the costs the best high level employees would simply go to banks away from the UK who didn't have those cost.

In short the bank did exactly what it had to do to retain its earners. Their share price will drop because of the loss of expected profits, but this is due to the government's action not the bank's. The bank is just trying to mitigate the damage.

[Indefease]

1. Everyone seems to think that the banks need to absorb this tax to stay competitive, but I doubt that in this situation, it would be unpractical for a banking executive to actually leave their bank to go to another bank.

Why? It is a one off tax. Suppose Bank A is not absorbing the cost, but Bank B is. Since the bonus that Exec has earned at Bank A is for the year current, if Exec left to Bank B, she would only be entitled to next year's bonus, in which case she may as well have stayed with Bank A.

So, other avoidance measures aside, as far as absorbing is concerned, I think shareholders should be angry.

2. I think the gov has calculated its risks. Indeed, if banks are to be made less competitive to an extent that they should be absorbing these taxes, then any stakeholder is at a worse position, including the UK gov.

[Too Much Fed]

How about a 105% bonus tax?

[Mr. E]

How about taxing the banks - not the bonus earner - on the size of the bonus. Just don't allow any charge against income for the bonus and treat it as earnings for the bank.
I bet the bonus will be much smaller with this setup.

[Min]

There is the old story about the man who got cursed out by his boss one day, and when he went home, he scowled at his wife, yelled at the kids, and kicked the dog. In any human system of any complexity effects reverberate through the system. In the story there were probably further consequences, perhaps involving other people. Economic costs are typically passed on, but who ultimately bears them is not necessarily obvious a priori. In addition, they may be amplified or diminished as they spread.

The U. K. investment bankers claim that they will simply increase the bonus pool, so that the after tax compensation will remain the same. This may anger the government. (Really?) And the stockholders. (Really!) Doc merlin blames the government. Will the stockholders? Will the public? When push comes to shove, will the bankers really increase their bonus pool?

"A haughty spirit [goes] before a fall," says Ecclesiastes. That is not just moral pabulum, these things happen. It happened to U. S. bankers in the Great Depression when they appeared before the Pecora commission. It happened to Ehrlichman before the Watergate committee. It may happen to bankers today. Or tomorrow.

As for using taxes to reduce inequality, it was tax cuts that aggravated it. It took decades to get where we are today, it may take decades to reduce it significantly. It may never happen. But, as Milton Friedman said, the politically impossible can become the politically inevitable.

[Leigh Caldwell]

This is a standard microeconomic question.

In a market in equilibrium, any external increase in the cost of doing business will be shared between both the supplier and the customer. Not necessarily equally - that depends on the elasticity of supply and demand. But it can't be borne entirely by one party (as long as the consumption and production functions are nonsatiated - which is very likely in this scenario).

A one-off bonus tax may be different, because it is a sunk cost and should not affect prices. But to a limited extent it is likely to affect expected future costs, and therefore will increase prices. Indeed, if there is a bonus tax on employees this year which is not repeated next year, then employees will essentially have benefitted from an increase in price without a concomitant increase in cost.

There are of course two separate transactions here: employee-bank and bank-customer. Each of them can be analysed in the same way (depending on where the tax is applied). Thus, if the tax is on the bank and not the employee (which is the case in the UK), then the bank - ceteris paribus - will increase prices to customers and reduce bonuses to employees in expectation of next year's tax. And again, if the tax doesn't happen, the bank ends up with some free money.

As Coleridge didn't say: Margins, margins everywhere nor any cent to earn.