How and Why to Make Goldman Pay

By now everyone, even the NY Times front page, has noticed the huge multi-billion dollar profits posted by Goldman Sachs and others in the financial sector. Naturally, at a time when everyone else is hurting, the instinct is to stop them or make them pay the money back to the government. The first question is "Why should they?" The usual answer is because we bailed out the finance industry, and they shouldnt make such huge profits on the backs of the taxpayers. I am sympathetic to this argument on simple fairness grounds, but it is important to answer a second question: "If we hit them with a huge payment, are we cutting off our nose to spite our face?"

My answer to the first question is that there is plenty of reason to think that it is entirely wrong that the financial sector runs off with such huge piles of money. And my answer to the second is that even if the financial sector were to quit doing what they are doing because of new taxes, there is good reason to believe we might be better off rather than worse.

First, to the extent that they are relying on taxpayer money, there is a prima facie case for taking the money back. We didn't bail them out so they could make profits - though I doubt that a smaller level of profits would have provoked such negative reaction - and so long as their profits are less than the amount the taxpayers pumped into them either directly or indirectly (and so far they are) then I feel on perfectly good moral ground taking the money back.

But there is a bigger case than that to be made - the truly obscene levels of profits in the investment banking industry have ballooned since the financial deregulation that happened at the end of the Clinton Administration (Gramm-Leach-Bliley). There is no question that the deregulation allowed huge gains and improvements in efficiency that could never have been gained before. For the investment bankers and their clients it was clearly a great thing. But here is the rub: that group - investment bankers and their clients - are all of them in the upper 5% of the income distribution. And this 5% is the only group in the whole economy that saw sustained income gains over the past decade.

So, what we had is a reform that increased income markedly but most of us didn't get any of the increase. What we DID get was much higher risk and volatility, which is a polite way of saying we are taking the hit for the economic crash of 2008-09. Most of us could only gain from the financial boon by having a stock portfolio, but those arent looking to great right now. Even with the recent increases, we have only recouped 50% of the losses since the crash began. I, for one, would be very happy with less efficiency but more stability. Unlike investment bankers, I don't make money on a down market just as easily as an up market. (In the interest of honesty, I used to be one of them - In a previous incarnation I was a bond trader - I was in charge of one of the largest traded portfolios in the UK gilt market back in the mid-1980's) It is not at all obvious to me that the bottom 90% of the income distribution would be worse off today if we had never done the reforms of 1999, had forgone the GDP increases that resulted, and had a somewhat less efficient financial sector.

So, how to get the money back? I think it would be a great thing to have another income tax bracket in the USA. Why not just tax those guys at 50% on income over $5 or 10 million? Sure, they would try to evade the tax by moving income offshore but we have an IRS - we could pay to chase them down if they try anything fishy. OH NO, they will say. We cant possibly work as hard if you take half our money over $5 million! Fine. Don't. But I will bet that the Goldmanites will scramble just as hard for $8 billion as they did for $16 billion.

But lets face it, that isn't going to happen with our current crop of politicians. (Its socialism!!) So how about a windfall profits tax? Or even a permanent tax on federally backed too-big-to-fail financial institutions? After all, there is clearly a well defined logic to this last idea: If we are all on the hook if they mess up, then they should contribute to the Treasury in return. We economists call that "internalizing the externality." That is, if their activities have a costly undesirable side effect that doesn't show up on their books - and this would seem to be the case here - then the cure is to find a way to make those costs come back to them, so they act according to society's cost/benefit calculation rather than their own private one.

And finally, some advice for those of them who don't like it and throw the inevitable hissy fit: Dont let the door hit you on the way out. We have plenty of people lined up who would love to have your job.