Obama Tax Good for TARP, but Does Little to Safeguard Financial System

The contours of President Obama's expected tax on financial firms are coming into focus.

It would hit banks, insurers and brokerages that have at least $50 billion in assets. That amounts to at least 50 companies. Notably, the U.S subsidiaries of foreign firms also would be subject to the tax, which presumably is meant to ease concerns that the plan disadvantages American companies. The goal is to raise up to $117 billion billion over 10 years, with revenue going to cover any public losses on TARP. The tax would be applied to companies' total assets, excluding deposits and Tier 1 capital, which is part of the core funds that indicates a bank's financial soundness. There also could be a discount for companies funded with insured deposits. The general idea here is to tax firms' riskiest capital. The formula resembles how the FDIC calculated the special assessment it levied on banks in 2009 to replenish its Deposit Insurance Fund.

Obama is expected to discuss the tax today, but the government won't spell the plan out in detail until the White House releases its annual budget early February.

A major question for financial firms is whether the tax will end after a decade or become a permanent surcharge. Once in force, taxes have a habit of staying that way.

That's of particular concern to Goldman Sachs (GS) and Morgan Stanley (MS), which would likely incur the largest charges under the tax (not surprisingly, both stocks are down this morning). Unlike a retail bank, the securities firms don't take deposits, financing themselves instead with wholesale funding.

The tax would definitely bite. For a Bank of America (BAC), which has more than $2 trillion in assets and assuming a tax rate of 15 basis points, it could amount to roughly $1.7 billion per year, according to investment research firm Concept Capital. JPMorgan Chase (JPM) would face a $1.9 billion annual hit.

Insurance firms potentially subject to the tax include AFLAC (AFL), Allstate (ALL), Hartford Financial (HIG), MetLife (MET; technically a bank holding company), Prudential (PRU) and Travelers (TRV).

The larger question, of course, is whether along with making TARP whole the tax would make the banking system any safer. Would it deter financial companies from taking foolish risks? It might do something to discourage financial firms from growing too big (to fail). On its own, almost certainly not. Much depends on how reform efforts play out in Washington.

Economic wonks have their doubts about whether the tax would reduce risk. Say Peter Boone and Simon Johnson:

By all means, implement a sensible tax system that creates a punitive disincentive to size in the banking system â€" if you can figure out how to make this work. Most likely, the big banks will game this, like they have gamed everything else over the past 30 years.

But don't think taxes are the answer. We need to go back to simple, transparent regulation, and much smaller banks.