Douglas Holtz-Eakin attempts to calculate the impact of the 2010 Doddâ€“Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank) on the growth of the economy.
What did Dodd-Frank do to the effective tax rate on banks? Consider, first, the burden of complying with the new regulations. The American Action Forumâ€™s analysis of the Federal Register indicates that the cumulative burden (including the market value of paperwork hours for compliance) is roughly $14.8 billion annually. Notice that after-tax income in the presence of the burden is:
[rL â€“ C â€“ Burden](1-tB)
where r is interest on loans (L), C is the cost of acquiring funds and other operations, and tB is the tax rate on banks. Suppose that instead of a burden, the same after-tax income was generated by simply raising the tax rate to tâ€™. Then, by definition:
[rL â€“ C â€“ Burden](1-tB) = [rL â€“ C](1-tâ€™)
[which] can be re-arranged to yield:
tâ€™ = tB + (1-tB)[Burden/(rL-C)]
To put some empirical meat on [this], the Federal Deposit Insurance Corporationâ€™s (FDIC) Quarterly Banking Profile (QBP) provides information on taxes ($67.5 billion) and net income ($151.2 billion) that permit one to compute an initial tax rate of 31 percent. Using the AAF burden data and (11) yields an increase to 37.8 percent from compliance burdens.
A similar approach can be used to transform the roughly 2 percentage point rise in the leverage ratio of the banking sector (from 7.5 to 9.5 percent) from 2008 to 2014 into a rise in the effective tax rate. The banking sector responded to Dodd-Frank by holding more equity capital, thus require it to have greater earnings to meet the market rate of return â€“ the same impact as raising taxes. In this case, the higher leverage ratio translates into a further increase in the effective tax rate to 40.3 percent, for a total rise of 9.2 percent.
Collecting results, the impact on economic growth is a decline in the per capital growth rate of 0.059 percentage points annually. Is this a big deal? Consider lowering the growth rate in the Congressional Budget Office baseline projections by exactly this amount between 2016 and 2025. The lower rate of economic growth translates into a total loss of $895 billion in GDP or $3,346 for every member of the working age (16 and older) population over those 10 years.