Greg Mankiw supports the bank TBTF fee

Greg Mankiw is one of the most prominent economists in the country and perhaps the most famous to have not taken a freakonomics-esque path to prominence.  An observant conservative, he and I usually disagree on most issues.  So I found myself quite heartened to read this from him today, “Nonetheless, on the economic merits, there may be a case for the bank tax.”

I prefer not to call the Financial Crisis Responsibility Fee a tax because the nomenclature counterproductive and the revenue the banks will surrender is a necessary first step towards forcing banks to internalize their external costs.  As anyone who has taken an introductory class on Coase can explain, social friction often arises from firms not internalizing the full impact their actions have on society.  Without internalizing the proper costs of their activities, the price they charge consumers does not incorporate all the costs entailed in the production of the good.

Anyway, Mankiw, at the end of his post, also implies that the banking industry has grown too large.  Mankiw:

Will the tax law in fact be so well written?   It certainly won’t be perfect.  But it is possible that it will be better than doing nothing at all, watching the finance industry expand excessively, and waiting for the next financial crisis and taxpayer bailout.

The bailouts of the past will surely lead people to expect bailouts in the future.  Bailouts are a specific type of subsidy–a contingent subsidy, but a subsidy nonetheless.

In the presence of a government subsidy, firms tend to over-expand beyond the point of economic efficiency.  In particular, the expectation of a bailout when things go wrong will lead large financial institutions to grow too much and take on too much risk.  [...] We have in effect turned much of the financial system into government-sponsored enterprises.
[...]We can offset the effects of the subsidy with a tax.  If well written, the new tax law would counteract the effects of the implicit subsidies from expected future bailouts.

Will the tax law in fact be so well written?   It certainly won’t be perfect.  But it is possible that it will be better than doing nothing at all, watching the finance industry expand excessively, and waiting for the next financial crisis and taxpayer bailout.