Leading article: An encouraging step towards reform

It is not only in the world of politics where the tectonic plates appear to be on the move. The International Monetary Fund, once a reliable stalwart of the neoliberal economic establishment, has come up with some unexpectedly radical proposals for taxing the global financial sector.

In response to a request from the G20 to investigate ways in which the international banking system might be made to pay back some of the money it received from governments during the 2008 meltdown, the IMF proposes not one, but two, new levies. The first would be a "financial stability contribution" extracted from banks and other systemically important financial institutions (initially a flat rate, but gradually refined so that financial sector activities that pose a greater risk would attract a higher charge). The second would be a general tax on profits and pay across the sector.

But the IMF does not stop there. It also recommends removing tax rules that encourage banks to fund their activities through excessive borrowing and a move to clamp down on tax avoidance by financial firms. The IMF urges the need for a global approach to this reform agenda in order to prevent banks and other institutions moving to more favourable political jurisdictions.

The financial sector can be expected to fight with all its considerable lobbying muscle against these proposals. We will hear warnings that new taxes and restrictions on finance will hit lending and undermine the fragile global economic recovery. Such self-serving arguments can be largely ignored. The global financial sector has become an oligopoly that extracts vast unearned "rents" from international economic activity. The fat profits being reported this month by the largest banks on Wall Street (which were all on death's door less than two years ago) are eloquent testimony to their economically privileged position.

The world's largest banks also benefit from de facto government guarantees of their liabilities that drive down the cost of their borrowing to artificially low levels, which represents another hidden subsidy from society. It makes economic sense to tax these rents, not least to recoup some of the vast economic costs these institutions have imposed on taxpayers around the world. Yet a better approach would be to reduce those rents by breaking up "too big to fail" financial institutions, knocking them off their politically powerful pedestal, and injecting some serious competition into the global lending market. This should, over time, have the effect of bringing down profits and bankers' pay. And rather than taxing the banks to pay for future bailouts, policymakers should be focusing on ensuring that future rescues are not necessary (or at least less cripplingly expensive). This all points to the need for a regulatory overhaul and radical structural reform.

Of course, if the IMF's new taxes are set at the right level and directed with sufficient precision the effect could be the same. Tax incentives could compel the mega banks to break apart of their own accord. Yet a more direct approach would be preferable when it comes to addressing the problem of an over-mighty global financial sector.

Andrew Haldane, the Bank of England's director of financial stability, noted in a speech last month that there are two ways in which governments have historically dealt with private sector activities that (like global finance) impose unacceptable wider costs on society: taxation and prohibition. For dealing with the banks, the IMF proposes taxation. That approach has its merits. But in the final analysis prohibition – in the form of breaking up the banks – is necessary too.