Bankers' pay is high because there's too much money in the finance sector

The EU's attempt to cap banker's bonuses trundles on. But it's misdirected, writes Alex Hern.

As predicted, George Osborne made a last-ditch attempt yesterday to prevent the EU's cap on banker's bonuses being institutedtelling the convention of finance ministers that he "cannot support the proposal on the table". Despite the suggestion from Germany of a minor tweak to the proposals, apparently to give Osborne the chance to claim he'd won concessions, the Chancellor continued with his opposition, and so Britain remains the only EU nation not in favour of the cap.

There is still some fine detail left to be negotiated over the next few weeks, so if Osborne doesn't want to make the politically significant choice of being explicitly out-voted by the EU for the first time on this issue he could change his stance; but, as the Guardian's Ian Traynor writes, "there was no doubt that the central decision, to clamp down on bonuses, was irreversible".

Now that victory is within their grasp, some in Europe are looking to the next battle. The Telegraph's Louise Armitstead and Bruno Waterfield report that Spain's finance minister, Luis de Guindos, is looking at applying the same rules to salaries overall:

“We are very much in favour of the limitation on variable remuneration but that’s not the only issue,” he said. “The question is also the entirety of remuneration, which is sometimes more important. And Spain’s position is that shareholders’ meetings must have a major involvement and should decide the overall remuneration of bankers.”

De Guindos' plan hints at the real aim of the bonus cap. As I wrote last week, there are a number of possible targets, and the cap is flawed at achieving any of them. It will do little to affect the balance of risk in the system; little to affect the overall remuneration of bankers; and, since bonuses are more of a historical artefact than a considered motivation to action, there's not really any reason to think that they actually have any effect from the start.

It's clear from de Guindos' words that at least some of the support for capping bonuses comes because it's seen as an easy way to reduce the pay of bankers; and that now that that's done, the salaries should be next in line.

But as the Guardian's Zoe Williams discovered, the money has to go somewhere. Tim Simons, "who works in operations for a government-owned investment bank", makes the point to her:

"When a bank makes money, it either pays to its employees; or it pays to its shareholders – the wealthy, I call them."
"But aren't the employees wealthy too?"
"No, traders aren't wealthy, they're just well-paid."

For similar reasons, I've heard bankers refer to their profession—with tongue firmly in cheek—as the ultimate victory of Marxism. It is, after all, an industry in which the workers have successfully captured nearly all the surplus value they create.

Simons seems correct that the trade-off the banks face is between handing money to employees or shareholders. Take this, from 2005 but still relevant:

During in the past four years, securities firms in the US paid $7bn more in bonuses than they made in profits, $3bn more in 2004 alone… And compensation stays high even when profits are down. When J.P. Morgan admitted to bad bets last month, it slashed its net income for the second quarter. But during the same period, it paid employees more than $4bn, as it has in each of the past four quarters. On average, shareholders got just one dollar $1 for every $4 paid to employees.

But what that highlights the real problem for people who feel that bankers' pay is inequitable, distortionary, or in some other way problematic: ultimately, the pay is just a symptom of the fact that banking is an extraordinarily profitable industry.

In the US, finance accounts for just 8 per cent of GDP, but almost 30 per cent of corporate profits:

Noah Smith, examining why that might be, suggests that banking as a sector has naturally enormous economies of scale, and very few diseconomies. Put them together, and the tendency toward monopoly in finance is even greater than it is in capitalism generally. And so banks gain monopoly (or, more accurately, oligopoly) status, and can extract monopoly profits.

That even fits with what Simons told Williams. His dichotomy— "money goes to the employees or the shareholders"—misses the fact that banks could use that money sloshing around to boost the amount they pay savers, lower the interest rate they charge on loans, or reduce the fees and charges they levy on customers. (That applies just as much to investment banking as conventional retail banking). In a competitive industry, that's what would happen; but finance isn't a competitive industry.

The vast sums of money floating around the system have to exit it somewhere. High pay—and high pay in the city particularly—has a corrosive effect on the nation, but to tackle it without addressing the anticompetitive nature of the finance sector overall is prescribing painkillers to heal a broken arm.

Alex Hern is a technology reporter for the Guardian. He was formerly staff writer at the New Statesman. You should follow Alex on Twitter.

Show Hide image

Q&A: What are tax credits and how do they work?

All you need to know about the government's plan to cut tax credits.

What are tax credits?

Tax credits are payments made regularly by the state into bank accounts to support families with children, or those who are in low-paid jobs. There are two types of tax credit: the working tax credit and the child tax credit.

What are they for?

To redistribute income to those less able to get by, or to provide for their children, on what they earn.

Are they similar to tax relief?

No. They don’t have much to do with tax. They’re more of a welfare thing. You don’t need to be a taxpayer to receive tax credits. It’s just that, unlike other benefits, they are based on the tax year and paid via the tax office.

Who is eligible?

Anyone aged over 16 (for child tax credits) and over 25 (for working tax credits) who normally lives in the UK can apply for them, depending on their income, the hours they work, whether they have a disability, and whether they pay for childcare.

What are their circumstances?

The more you earn, the less you are likely to receive. Single claimants must work at least 16 hours a week. Let’s take a full-time worker: if you work at least 30 hours a week, you are generally eligible for working tax credits if you earn less than £13,253 a year (if you’re single and don’t have children), or less than £18,023 (jointly as part of a couple without children but working at least 30 hours a week).

And for families?

A family with children and an income below about £32,200 can claim child tax credit. It used to be that the more children you have, the more you are eligible to receive – but George Osborne in his most recent Budget has limited child tax credit to two children.

How much money do you receive?

Again, this depends on your circumstances. The basic payment for a single claimant, or a joint claim by a couple, of working tax credits is £1,940 for the tax year. You can then receive extra, depending on your circumstances. For example, single parents can receive up to an additional £2,010, on top of the basic £1,940 payment; people who work more than 30 hours a week can receive up to an extra £810; and disabled workers up to £2,970. The average award of tax credit is £6,340 per year. Child tax credit claimants get £545 per year as a flat payment, plus £2,780 per child.

How many people claim tax credits?

About 4.5m people – the vast majority of these people (around 4m) have children.

How much does it cost the taxpayer?

The estimation is that they will cost the government £30bn in April 2015/16. That’s around 14 per cent of the £220bn welfare budget, which the Tories have pledged to cut by £12bn.

Who introduced this system?

New Labour. Gordon Brown, when he was Chancellor, developed tax credits in his first term. The system as we know it was established in April 2003.

Why did they do this?

To lift working people out of poverty, and to remove the disincentives to work believed to have been inculcated by welfare. The tax credit system made it more attractive for people depending on benefits to work, and gave those in low-paid jobs a helping hand.

Did it work?

Yes. Tax credits’ biggest achievement was lifting a record number of children out of poverty since the war. The proportion of children living below the poverty line fell from 35 per cent in 1998/9 to 19 per cent in 2012/13.

So what’s the problem?

Well, it’s a bit of a weird system in that it lets companies pay wages that are too low to live on without the state supplementing them. Many also criticise tax credits for allowing the minimum wage – also brought in by New Labour – to stagnate (ie. not keep up with the rate of inflation). David Cameron has called the system of taxing low earners and then handing them some money back via tax credits a “ridiculous merry-go-round”.

Then it’s a good thing to scrap them?

It would be fine if all those low earners and families struggling to get by would be given support in place of tax credits – a living wage, for example.

And that’s why the Tories are introducing a living wage...

That’s what they call it. But it’s not. The Chancellor announced in his most recent Budget a new minimum wage of £7.20 an hour for over-25s, rising to £9 by 2020. He called this the “national living wage” – it’s not, because the current living wage (which is calculated by the Living Wage Foundation, and currently non-compulsory) is already £9.15 in London and £7.85 in the rest of the country.

Will people be better off?

No. Quite the reverse. The IFS has said this slightly higher national minimum wage will not compensate working families who will be subjected to tax credit cuts; it is arithmetically impossible. The IFS director, Paul Johnson, commented: “Unequivocally, tax credit recipients in work will be made worse off by the measures in the Budget on average.” It has been calculated that 3.2m low-paid workers will have their pay packets cut by an average of £1,350 a year.

Could the government change its policy to avoid this?

The Prime Minister and his frontbenchers have been pretty stubborn about pushing on with the plan. In spite of criticism from all angles – the IFS, campaigners, Labour, The Sun – Cameron has ruled out a review of the policy in the Autumn Statement, which is on 25 November. But there is an alternative. The chair of parliament’s Work & Pensions Select Committee and Labour MP Frank Field has proposed what he calls a “cost neutral” tweak to the tax credit cuts.

How would this alternative work?

Currently, if your income is less than £6,420, you will receive the maximum amount of tax credits. That threshold is called the gross income threshold. Field wants to introduce a second gross income threshold of £13,100 (what you earn if you work 35 hours a week on minimum wage). Those earning a salary between those two thresholds would have their tax credits reduced at a slower rate on whatever they earn above £6,420 up to £13,100. The percentage of what you earn above the basic threshold that is deducted from your tax credits is called the taper rate, and it is currently at 41 per cent. In contrast to this plan, the Tories want to halve the income threshold to £3,850 a year and increase the taper rate to 48 per cent once you hit that threshold, which basically means you lose more tax credits, faster, the more you earn.

When will the tax credit cuts come in?

They will be imposed from April next year, barring a u-turn.

Anoosh Chakelian is deputy web editor at the New Statesman.