The German bank saver’s tax

This is a thought experiment. I have written in favour of private sector involvement in the past. And I don’t think this is a controversial topic. Where I do have problems with the Cypriot bank saver’s tax is in terms of property rights and  law.

In Cyprus, the problem is the Icelandic one: how to treat bank lenders when the banking system is both insolvent and  disproportionately large when compared to the economy. The Irish faced this problem first in the euro zone and heaped the burden onto the sovereign, crippling it in the process. They are still trying to retroactively remove part of the burden. The alternative would have been extracting losses from senior debt holders, something the Irish were unwilling to do. And something the Swedes were also unwilling to do in the 1990s.

Cyprus faces a similar problem to Ireland and Iceland in that its banking system is very large relative to the size of the economy and is likely insolvent. The key difference for Cyprus is that Cypriot banks have very small levels of senior and subordinated debt, meaning that any private sector involvement necessarily must fall onto depositors. This fact is the source of worry as banking is a leveraged endeavour and deposits are a multiple of available cash, such that a bank run leads inevitably to insolvency.

Blanket deposit guarantees are not credible when the banking system is so outsized because the sovereign cannot make good on it. So traditionally you keep the guarantee small to protect ordinary citizens and let  big-time depositors take on the risk of having their funds expropriated in the case of insolvency.  And clearly, if you are going to have a deposit guarantee, taxing deposits that fall within that guarantee’s remit severely diminishes the credibility of that guarantee ( and others like it in the same currency area).

Enough of the background – anyway, as I was thinking about the Cypriot bank saver’s tax, it occurred to me that you could replicate it elsewhere in non-emergency situations and ask questions about the differences. Let me do that using Germany.

Imagine the German Chancellor came on TV and told the German citizens that Germany had lived beyond its means and that its banks were overextended as was the government. She said, “mind you, we are still a AAA country with a safe banking system. Nonetheless, we are worried that we are not safe enough and intend to remedy this.” Like the solidarity tax used during reunification, the Chancellor proposes a bank solidarity tax levy to recapitalise the banks to meet the Basel 3 requirements without burdening the public balance sheet. The benefit of the tax is that German depositors get shares in the banks exactly equal to the value of their deposits. The Chancellor ends by saying that, “we have yet to work out how much of a solidarity tax we will take but it will extend to all depositors, no matter how small out of fairness. Initial estimates call for a tax of 6.9% on all deposits and 9.9% on deposits over 100,000 euros. Doing this now is better than waiting for the crisis elsewhere to affect us here in Germany as well.”

What do you think – is it legal? is it fair?

Running through that example, the first thing that comes to mind for me is that it is unnecessary. So why do it? That’s the only real difference between this hypothetical and what is occurring in Cyprus. Otherwise the two scenarios are designed to be identical. And the rationale of preparing for Basel 3 makes some sense. That’s my first take. On the legality, it is perfectly legal as well. It is a tax. Sure it taxes insured deposits but it is still legal. The fairness issue is the problem. One day you go to sleep and the next day you wake up to find your money taken in what seems to be an arbitrary way. What are they going to tax next? You could have kept your money under a mattress and this never would have happened. Had you bought physical gold, your wealth would have been preserved, your brother-in-law, the gold bug, tells you annoyingly.

But, couldn’t the government just come right out and declare an equivalent solidarity tax on all taxpayers instead. What’s the difference here except that the bank tax more closely equates the bank capital problem with the source of bank capital as the source of the tax? Isn’t it more fair that the tax come from those who use the banks? Even so, it does seem unjust and simply ridiculous – and I think the reason is ultimately the arbitrariness of the action. A tax is a tax. Nothing is certain except death and taxes, right? So in principle a government could tax any- and everything in its domain. The question goes to how it goes about doing it, how it justifies the tax and who gets the levy.

I don’t have anything else to add here since I don’t want to get too deep into the philosophical discussion of state tax. However, you can see from this hypothetical that, on the face of it, there is nothing wrong in principle with a tax to recap the banking system. The Cyprus problem goes to fairness and process. The question is who pays and how it is justified.