Bonus killers - careful what you wish for

It was the day a friend who works at a hedge fund told me his boss was looking into buying a Harrier Jet, about 3 hours after I'd had a fraught conversation with a mother of a pupil at my old school who couldn't afford to buy him replacement school uniform that I realised something was wrong with the way money is distributed in this country. This is the prism through which we need to look at the current debate over the bank bonuses which are about to be paid out. Yet, like every issue, it is complicated, because the government intervention that is being sought could be more damaging than most realise.

Somehow, apparently, the government is supposed to 'take action' over bonunes like they promised before the election. What this 'action' is, nobody can say, apart from the idea that those who work at the banks that are majority government owned (particularly RBS) should not be paid big bonuses at all.

The reasons for this are pretty unarguable. We are, apparently, "all in this together" (Osborne, G. 2010). We are all going to be hit by government spending cuts and tax rises, and there could be job losses. If everyone really is 'all in this together' then people who work in banks should not be getting massive bonuses. After all, it was the banks who caused this financial meltdown (although they did not, repeat not, cause the structural deficit) and government money was used to bail some of them out so paying out billions of that money in bonuses seems callous and crazy.

Suggested actions the government could take include: Taxing any cash bonuses at 50%, ordering RBS not to pay bonuses over a certain figure, a windfall tax on the profit pool from which bonuses were going to be paid, forcing the banks to lend more to small businesses and first time buyers and, well, it's not particularly clear. The hope was that the banks would be 'shamed' into not paying massive bonuses. Here's why none of the above will happen:

1) Bankers get bonuses. That's it. The job actually has very little other rewards. You don't meet your clients often and job satisfaction is minimal. It's all about a number. That number is the bonus you get paid at the end of the year. To use economic language, the pecuniary rewards are all, the non-pecuniary rewards are pretty much non-existent. Your entire sense of self-worth in the workplace is based upon your bonus and if it isn't big enough you leave. I'll come back to that sentence later.

2) Banking can be done from anywhere. So, at the moment the country gets a huge amount of tax from the financial services community but the banks could easily do their work in another country such as Switzerland. If the UK put a windfall tax on banks then it has to be done in other countries or the banks will go to those other countries, and the UK loses jobs and tax revenue that it cannot do without. It may be worth looking at the profits from which the bonus pool is paid. Some of those profits could be classed as "normal" profit - which is the acceptable return on the capital employed in setting up and running a business. Some, though, could be "supernormal" or "monopoly" profits, gained because the banking sector is dominated by massive companies charging much higher fees than they would in a competitive market.Trying to tax these monopoly profit though will only work if other countries do it.

3) If a bank pays £7 billion in bonuses over £3billion of that comes back in taxes. Any bonuses that take the annual remuneration over £150,000 is taxed at 50% anyway. If the bank doesn't pay it out as bonuses then they would need to declare it as profits, which is taxed through corporation tax, about to go down to 27%. This would mean a massive drop in tax revenue receipts if it were that simple. But many banks lost so much money a few years ago that they can effectively write those losses off against corporation tax for a long time, so the UK would less get revenue. This is, in economic terms, actually the strongest argument against most of what the opponents of paying bonuses are suggesting.

4) Yes, the government own RBS. We own RBS. It sticks in the craw that we pay out so much of what seems like "our" money out in bonuses. But what would happen if we decided that RBS staff don't get the bonuses? RBS is not like a normal nationalised firm. Taking ownership of it was always a short-term option, and the clear intention is to sell it back into private hands for a profit. This would help clear the billions of pounds of debt we have. Given it was nationalised when it was on its knees, if the government can wait until RBS builds its balance sheet up to full strength again it should be able to sell at a significant profit. To do that, RBS needs to be competitive. To be competitive it needs the best employees. To have the best employees you have to have competitive pay. If bonuses are cut, those employees will leave, RBS will be less competitive, and its value will plummet. Again, be careful what you wish for.

5) Making an apparent deal to make the banks lend more to small businesses and first time buyers in return for leaving them alone on bonuses sounds like a good idea. But on lending banks have been put in a difficult position. Having been castigated for irresponsible lending they reined in their lending and are now being asked to let it out again. What if what has actually happened was that the level of lending they are at now IS the responsible lending level? I just re-mortgaged, and it was extremely hard and took a great deal of time, with far more difficulty in getting the re-mortgage approved despite a perfect credit record and not borrowing a huge amount compared to income. I was quite sanguine about this, because this is perhaps what should have happened 4 years ago when I got a mortgage for over 5 times my income. What if lending to small businesses and first time buyers on a looser basis returns us to the same problems? Who will take the blame?

All government intervention in any market can lead to government failure. Intervening in the paying of bonuses could be a great example of that. This is not to say there isn't a moral case against the paying of excessive bonuses. They distort housing markets all over London and other areas where second homes are rife.  They are also particularly difficult to stomach for those in our population not sure where their next meal is coming from.

It might be better if instead of looking for a harrier jet, the hedge fund manager at the top of this article looked for an anti-poverty charity to give to. But some people have no shame. Just a massive amount of money.