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Britain's Chancellor Shows Lack Of Judgment With Windfall Bonus Tax

After calamitous financial events, it is common for all sorts of silly, anti-competitive financial policies to sprout up from the populist-infused aftermath. Such was the case with the introduction of Sarbanes-Oxley in the early decade: instead of keeping accounting standards more tightly policed, the regulation had the deeper effect of sending a whole generation of Chinese enterprises eastward in their search for capital in order to avoid burdensome U.S. regulations.

Britain today is experiencing something of a Sarbanes-Oxley moment. Earlier on, Chancellor Alistair Darling announced that banks will be forced to pay a one-time levy of 50 percent on bonuses higher than £25,000, or $40,800. In addition, top-rate income tax on earnings of more £150,000 will rise to 50 percent, he said:

"There is no bank that has not benefited either directly or indirectly from this help," said Darling, who ruled out a tax on banks' profits. "I'm giving them a choice. They can use their profits to build up their capital base, but if they insist on paying substantial rewards, I'm determined to claw money back for the taxpayer."
At first glance, it might seem like a fair justification -- and even a good thing -- that banks are being encouraged to hoard more cash to plough into their operations, rather than to pay out telephone-number-sized salaries.

However, that's only until you consider that a financial services firm is not a value-chain business, but rather a value-shop business. In the case of a value chain, such as Wal-Mart Stores (WMT), for example, the business needs continued re-investment in technological infrastructure to grow. That is different for a value shop such as a financial services firm, whose main re-investable infrastructure is pretty much only its employee base.

It is for this reason that Morgan Stanley (MS) is shopping around for more than 400 sales and trading employees right now, JPMorgan (JPM) is hiring 1,200 retail bankers, and Japanese Nomura (NMR) is looking to swell its U.S. personnel roster by 1,600 additional hires by March next year. The bulk of those employees will be paid a basic salaries plus company- and individual-based performance bonuses. The reason is because their work directly affects the bottom line of the bank.

In other words, punishing banks for their willingness to pay market rates for their employees is exactly the same as getting tough on Costco (COST) for sourcing cheap goods to stack its shelves with. By imposing a scary windfall tax on banks' principle area of growth and investment, Darling is merely dissuading firms from expanding operations in London, and instead, incentivizing them to expand elsewhere in Europe.

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