Hard Lessons in Regulation

In an intriguing confluence of events, the UK and France may separately enact legislation that overall does more harm than good—another hard-learned lesson of regulation’s common unintended consequences.

In a bit of news that seemingly belongs more in the (choose a number between 11 and 16)th century, it’s possible the French may soon invade England. Or vice versa. Hard to say at this point (as it frequently was through centuries of spats during which both countries’ sitting monarchs had periodic tendencies to rather unceremoniously proclaim themselves king of the other). The reason this time, though, is quite different—rather than fighting over accession rights, land, the Spanish, slights (real or imagined) to distant cousins or any number of other historic causes, the invasion may be prompted by taxes and regulation.

French presidential candidate FranÇois Hollande is proposing a 75% top income tax rate should he win the upcoming election. A high rate indeed—particularly on top of the VAT and other taxes paid by French citizens. However, it seems rational to assume the chances anyone actually sticks around long enough to pay that rate (or reports enough income to qualify) are exceedingly low. And in fact, it appears the French “invasion” of London has already begun—Hollande even made a recent trip to London to campaign to French citizens living there. (Incidentally, based on the number of French living there, London is currently among the top six cities in France. Henry VIII—or any other Roman numeral—would’ve been proud.)

Should the higher tax go into effect, expect the outflow from France to continue. Few would argue a 75% top tax rate is encouraging to the entrepreneurial minded. And with European rules fairly lenient surrounding relocation, it’s pretty simple to move where taxes and regulation are overall less onerous and more economically encouraging.

Meanwhile, though, it seems possible UK banks may very well catch the Eurostar through the Chunnel going the opposite direction, where bank regulation could soon prove less onerous. Various reform proposals have been put forth for years, and on February 29, yet another was introduced in the UK parliament—a bill that could fundamentally reform the UK banking system. Should the proposal pass as-is, the primary result would be to assign unlimited personal liability for any bank losses to bank board members. They would also be required to provide personal bonds that would potentially be forfeit in the event of bank losses.

Now, the chances the legislation actually passes seem fairly slim at this point—it’s not part of the coalition’s agenda and was presented by a back-bench member of parliament at what amounts to an open forum. And as with all legislation, it’s important to keep in mind the myriad political powers at work. But here’s what all such recent proposals seemingly boil down to: Politicians (and presumably, some constituents) feel banks, and indeed the bankers themselves, are directly responsible for credit dislocations and other systemic weakness the UK (and other European nations) faced in recent years. Therefore, proposals aim to limit, tax or otherwise put the kibosh on bankers’ bonuses and/or pay, presumably to prevent a recurrence of perceived bad banker behavior.

If you want to make bank executives personally liable for bank losses (as the legislation proposes), it would seem logical executives would seek significantly higher pay—after all, they’re assuming additional and large personal risk, so they’ll no doubt seek commensurate reward. Yet ironically, that outcome would place this proposal directly in conflict with other reforms (with similar aims to discipline banks) proposed earlier—specifically those calling for banker bonuses to be curtailed.

And therein lies the rub with such legislation—you can’t really have it both ways in practice. And if you try to, it seems pretty logical banks will do what they can to avoid such restrictions on their ability to operate and hire capable, competent executives: They’ll relocate (if they can).

Should both Hollande’s tax and the British reforms become law, it could create something of an odd (if currently entirely hypothetical) scenario in which French citizens (particularly high earners) are relocating to the UK to avoid onerous personal taxes in France. Yet they won’t be able to secure jobs in finance—UK banks will be busy relocating, too. Maybe to France! But alas, upon landing anew in Calais, banks and bank executives realize their top earners will no doubt be subject to high personal taxes. So it seems the unlikely winner of this financial Battle of Hastings could well be ... Singapore! Or maybe Hong Kong. Or maybe (ironically) Wall Street! Dublin. Or really anywhere with a friendlier climate when it comes to both regulation and taxation.

The moral of the story is this: Regulation and taxation are both essential parts of a functional, effective government in any country. But in an increasingly globalized world, where it’s becoming ever simpler to emigrate (particularly within Europe) and easier for businesses to operate on foreign shores, the competition among countries to become home to entrepreneurs and businesses will similarly become increasingly stiff. The ultimate losers will likely be those countries who indicate—implicitly or explicitly—they’ll regulate and/or tax as much as they can the profits of businesses and their employees domiciled there.

But the winners will be those countries which encourage businesses and their employees—through reasoned, sensible regulations that aim primarily to ensure a level playing field and the efficient functioning of as free a market as possible. Yet another lesson in the law of unintended consequences—and the myriad benefits of Capitalism.

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*The content contained in this article represents only the opinions and viewpoints of the Fisher Investments editorial staff.