July 29, 2015 | Commentary on Budget and Spending, Federal Spending, Economy

Milking Banks For Highways

The U.S. Senate’s newest plan to save the highway trust fund is a great example of how short-term interests tend to dominate politics. As my colleague Michael Sargent has pointed out, the Senate developed a six-year plan that pays for only three years, and “does so by relying on unacceptable gimmicks and tax increases.

One of those tax increases provides another terrific political lesson: If you belong to an unpopular industry, watch out.

The Senate’s highway deal would slap a new tax of roughly $16 billion on banks, the industry that has been relentlessly blamed (along with Wall Street) for the 2008 financial crisis.

The highway fund has virtually nothing to do with banking, but taxing an unpopular industry to get more revenue trumps that fact by a mile. (And never mind that the banks would merely pass the new tax costs on to their customers.)

The specific item in question here is a dividend that the Federal Reserve pays to member banks. As a condition of joining the Federal Reserve System, banks are required to buy into the stock of their district Fed bank. In return, the Fed pays the banks a 6 percent dividend every year.

The new Senate plan would reduce the dividend to help pay for the highway money. According to Bloomberg:

"The largest single provision would change the 6 percent dividend paid by the Federal Reserve to member banks. It would be reduced to 1.5 percent for banks with more than $1 billion in assets while remaining at 6 percent for smaller banks."

This little scheme highlights several interesting facts.

First, politicians love to help out “small” businesses. It’s a big win in this case, because Congress can say they didn’t impose the tax on small banks while their cutoff ensures they tax the bulk of banks’ total assets. (Using 2014 data, commercial banks with assets greater than $1 billion represent more than 90 percent of all banking assets.)

The Senate’s plan also drags the Fed into the mix, and they’ve pretty much always been a target for populist attacks that outweigh common sense. Many Fed critics, for instance, blame the Fed for all sorts of evils and claim that the true source is the private interests controlling the Fed.

The Senate’s plan is a perfect match for this story because it focuses on so-called stockholders in the Federal Reserve System. But this entire arrangement, where banks contribute capital to the Fed system and then receive dividends, is more nominal than anything else.

Yes, these banks have shares in the Fed District Banks, but they can’t really do anything with them. Whereas shareholders in a public company can trade or sell their stock, that’s not the case here.

The banks don’t vote on monetary policy decisions or regulatory actions. They don’t decide how much money the Fed has to turn over to the U.S. Treasury each year.

And if a bank decided to leave the system, it would still be required to maintain its reserve account at the same District Fed Bank. (Even non-members have to.)

The truth is the Federal Reserve System is run by the Fed’s Board of Governors, a full-fledged federal agency. It’s been that way since the 1930s, and we do a disservice to ourselves when we treat the Fed as anything but a government agency.

Lowering the dividend isn’t going to punish an evil cabal of bankers running the Fed because that particular cabal doesn’t really exist.

In this particular case, though, the Senate clearly views the Fed for exactly what it is: a federal agency.

The Federal Reserve Act stipulates that all annual profits from the Fed’s operations have to be turned over to the Treasury, and this amount is typically billions of dollars each year. For the last 10 years the Fed has annually remitted between approximately $19 billion (in 2004) and $88 billion (in 2012).

So the Fed is a significant source of revenue for the government, and now some members of Congress want more. And no matter what the spin, this dividend reduction amounts to a tax, just as any other source of federal revenue.

The reduction would send more money to Washington by taking away a portion of banks’ revenue, ostensibly to fund highway projects. Ironically, nobody in Congress has yet spoken up about what this tactic implies for the Fed’s independence.

Reducing the dividend also amounts to taking more money out of the Federal Reserve System to fund fiscal policies. Taxpayers will ultimately foot the bill, but the fact remains that Congress would be explicitly taking money out of the Fed to pay for fiscal projects.

Isn’t anyone in Congress worried that this move will put more political pressure on the Fed? During the last few years quite a few Senators expressed their eagerness to keep Congress out of the Fed’s business.

But I suppose directing the Fed to hand more money over to the Treasury is fine as long as we can pretend that banks are paying for it.

The new bank tax is only one of the many problems with this highway bill, and it’s difficult to say what counts as the worst component. The bill does nothing to address the long-term problems in the Highway Trust Fund. Indeed, it exacerbates them by adding spending for new programs.

In many ways this bill is the same old tax and spend policy we’re used to in Washington. It’s rare, though, that Congress exposes the Fed in this way. Hopefully, people will take this opportunity to see the Federal Reserve for what it really is: a government agency that provides revenue to the Treasury.

And that revenue is our money, just like all the other taxes we pay.

- Norbert J. Michel is a research fellow specializing in financial regulation for The Heritage Foundation’s Thomas A. Roe Institute for Economic Policy Studies. He is also a co-author of Heritage’s "Opportunity for All; Favoritism to None.”

This article originally appeared in Forbes. The original piece can be found at http://www.forbes.com/sites/norbertmichel/2015/07/27/milking-banks-for-highways/.

About the Author

Norbert J. Michel, Ph.D. Research Fellow in Financial Regulations
Thomas A. Roe Institute for Economic Policy Studies