Taxing Big Banks for Being "Too Big to Fail"

After three years of work, last week Rep. Dave Camp (R-Mich.) put forward the proposed "Tax Reform Act of 2015." The first major tax reform proposal in years, the bill proposes major changes to the tax code for both individuals and companies. One of the many noteworthy proposed changes is a new tax on "systemically important financial institutions" for the implicit subsidy of being deemed "too big to fail." Read on for what was proposed, the companies that will be affected, and what it means for you.

Too big to fail
The basic idea of "too big to fail" is that the biggest banks in the world are now so large and interconnected that their collapse would be a disaster for the economy. The failure of one of them would be too much for the economy to handle, so the government would have to intervene. For those interested, Fool analyst John Maxfield wrote an interesting history last year of how banks became too big to fail.

With the passage of Dodd-Frank, regulators began deeming certain financial institutions with more than $50 billion in assets as systemically important financial institutions (SIFIs). This may have compounded the problem; many economists argue that banks benefit from their "too big to fail" status, as the market expects the government will step in if there are problems, and so gives them lower funding costs. Lawmakers have been trying to end this implicit subsidy, and the Tax Reform Act proposes a solution.

Excise tax on "too big to fail" financial institutions
The Tax Reform Act of 2015 proposes a quarterly excise tax of 0.035% on assets exceeding $500 billion for SIFIs. The stated reason for the tax is that "while tax reform cannot undo Dodd-Frank, it can and should help recapture a portion of that implicit subsidy." Overall, the Joint Commission on Taxation expects this would raise $86 billion over the next decade.

Who would be affected
The $500 billion in assets level is high enough that it would apply to just nine companies -- potentially 10 by 2015.

*MetLife is in the final stage of the SIFI designation process. Source: Federal Reserve, S&P Capital IQ, author's calculations.

As you can see, the tax would be a significant penalty on financial institutions that grow much beyond $500 billion in assets. It should be noted that this is just a proposal, and I'm sure the industry will fight this as hard as it can.

Will it pass?
In 2010, the Safe Banking Act tried to end "too big to fail" by setting up a number of regulations to cap banks based on size, sources of funding, and leverage. The bill failed to pass by 61-33, as many worried that more regulation and bureaucracy was not the answer to the problem.

I am optimistic that this excise tax will pass, as it is a simpler way to solve the problem of "too big to fail," and lawmakers seem up to it. On March 22, 2013, the Senate approved, by a unanimous vote of 99-0, a bipartisan amendment to the Senate budget resolution endorsing legislation to end subsidies and funding advantages received by "too big to fail" banks with total assets of more than $500 billion.

Bottom line
"Too big to fail" is still a growing problem that has only gotten worse since the financial crisis, and the excise tax on "too big to fail" looks like a good start to ending it.

A Bank You Can Feel Good About
Do you hate your bank? If you're like most Americans, chances are good you answered yes to that question. While that's not great news for consumers, it certainly creates opportunity for savvy investors. That's because there's a brand-new company that's revolutionizing banking, and is poised to kill the hated traditional brick-and-mortar banking model. And amazingly, despite its rapid growth, this company is still flying under the radar of Wall Street. For the name and details on this company, click here to access our new special free report.

The article Taxing Big Banks for Being "Too Big to Fail" originally appeared on Fool.com.

Dan Dzombakcan be found on Twitter @DanDzombakor on his Facebook page,DanDzombak. He owns shares of Bank of America. The Motley Fool recommends American International Group, Bank of America, Goldman Sachs, and Wells Fargo. The Motley Fool owns shares of American International Group, Bank of America, Citigroup, General Electric Company, JPMorgan Chase, and Wells Fargo and has the following options: long January 2016 $30 calls on American International Group. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

Copyright © 1995 - 2014 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.