Last September, leaders of the Group of Twenty (G-20) industrial and emerging market countries, meeting in Pittsburgh, asked the IMF to prepare a "range of options" for "how the financial sector could make a fair and substantial contribution toward paying for any burdens associated with government interventions" to counteract financial sector crises.
IMF First Deputy Managing Director John Lipsky leads the Fund group tasked with preparing the report.
In this interview, Lipsky explains how the IMF will go about its work as it studies various approaches. The final report will be presented to the G-20 Leaders next June, with a preliminary version to be discussed at the G-20 Finance Ministers meeting in April.
IMF Survey online: There's a lot of interest in the work that the Fund is doing on taxation of the financial sector. What exactly is this about?
First of all, I want to be clear about the subject and scope of our report. We are responding to the G-20 Leaders' request for an analysis of the various ways in which the financial sector could help to defray the costs of public sector crisis support. Since you mentioned "taxation," I would stress that while this may provide a convenient shorthand reference for the project, our report will encompass other possible funding sources, including some that resemble user fees.
Although we will focus principally on the funding challenges posed by potential future crises, we also will examine the efforts underway to recoup the cost of the current crisis. Of course, there are many links between these two, but the analytical approach-and the appropriate policy choices-inevitably will differ in each case.
At the same time, our study will examine which institutions and/or activities should be included, and in the case of future crises, whether a fund should be created in advance of any prospective use. In analyzing the various policy options, important considerations will include bolstering systemic efficiency and effectiveness, including by removing existing distortions and by avoiding the introduction of new ones.
IMF Survey online: What do you see as the main challenges for this work?
At its heart, our analysis will address how to fund the direct financial sector support that could be required in a potential financial crisis. Assessing this need will require analysis of the spillover effects-that is, externalities-that financial sector activities pose for the rest of the economy. At an analytical level, the burdens resulting from financial crises can be addressed through taxation, or regulation, or a mix of the two. Thus, a key question that our analysis will have to confront is the appropriate balance between these two basic policy options.
Lipsky: "These are issues that lie at the intersection of macroeconomics, regulatory economics, and public finance."
For example, a more tightly regulated financial system presumably would be more stable, and therefore would create less prospective risk. In this case, the potential burden of public sector support should be lower, as would be the possible need for funding. However, a financial system that was severely constrained with regard to permitted activity likely would provide fewer services and could even reduce overall output.
Unfortunately, the academic literature provides little practical guidance for finding an optimal balance between financial regulation and crisis mitigation. Thus, we will be breaking new ground. Of course, this makes the work not only potentially important, but also intellectually challenging and even exciting.
The challenges are somewhat daunting, however. The issue is situated at the intersection of macroeconomics, regulatory economics, and public finance. We need to take into account the tightly integrated and complex nature of contemporary financial markets. We will have to be aware of the regulatory changes currently being discussed by G-20 members at the Financial Stability Board. We will have to consider in practical terms how possible measures could be implemented internationally without creating perverse incentives.
We also will have to be mindful of the near-term difficulties still facing the financial sector, so as to avoid the danger that any proposed measures could unduly jeopardize the sectors' recovery. Adding to the challenges, any eventual policy decisions in this area will involve judgments about fairness and efficiency-issues that inherently are difficult and often contentious.
As is self-evident, we will require a wide range of practical and conceptual expertise. To accomplish this task, we are drawing on the really impressive capabilities of our Fiscal Affairs Department, the Monetary and Capital Markets Department, and our Research Department. In fact, the staff team working on this project is absolutely world class.
That does not diminish the difficulties of finding the right solutions. Not the least of the challenges we face is a tight timetable; the final report to the G-20 Leaders is due in June 2010 and we will present a preliminary version to G-20 Finance Ministers in April.
IMF Survey online: What measures are you focusing on-and are there any you have ruled out?
At this stage, we have ruled nothing out. We will look at various taxes, the formation of resolution funds, and the possibility of capital charges or the creation of contingent capital requirements. The latter term refers to debt finance that converts into equity in pre-specified circumstances related to stress, and that potentially could prevent some bank failures. Of course, even before we look to use the tax system to fund crisis resolution, we need to ask whether current tax rules favor excessive risk-taking, and if so, how such problems could be corrected.
IMF Survey online: What about the idea of a Tobin tax on foreign currency transactions, or a more general financial transactions tax, which some have proposed?
Of course we will examine all worthwhile proposals. However, the original "Tobin tax" proposal-first suggested by the late Nobel laureate James Tobin-was limited to foreign exchange transactions, and was intended to reduce the volume of such transactions, not to raise revenue. While some contemporary advocates of a transaction tax view it as a means to shrink the size of the financial sector, others are looking to such a measure as a possible source of finance for development purposes. Whatever the merits of this approach, and the worthiness of the overall goal, this is not exactly the issue that the G-20 Leaders asked us to analyze.
IMF Survey online: There are clearly strong views on the topics that you are exploring. How do you plan to take them into account?
Clearly, these are issues that have attracted widespread attention, and they merit broad consultation. Already, we are engaging the views of interested observers and recognized experts in the area. We envision this process to include official institutions, academics, financial market participants, civil society organizations, and all others with an interest in contributing to the discussion.
IMF Survey online: We are seeing some examples of banks that received substantial support during the crisis that are now making arrangements to repay governments for that support. How will the IMF take this into account?
We currently are surveying the G-20 countries regarding the types of public support already extended to financial institutions, and the repayments that have been made and are expected to be made in the future. The amount of temporary support being made available to the financial sector surely will have some relation to the net cost to the public of such actions, rather than just the gross cost. Moreover, it will be important to examine the incidence of proposed fund-raising measures, in order to understand as much as possible their ultimate economic impact, and not just their first-round effects.
