Tax Workstream

This post sets out in more depth the work that will be undertaken in this workstream.

This workstream explores issues relating to bank taxation and regulation. There are two predominant ways of taxing banks with the goal of improving financial stability by discouraging risky activities. One is in the form of prudential regulations imposed by the authorities (‘regulatory taxes’) and the other is through revenue raising ‘fiscal’ taxes. Prudential regulations such as capital and liquidity requirements have traditionally been the dominant means of trying to ensure banking stability. It tends to be bank specific and to provide for a private buffer or insurance of the risks of individual banks. Fiscal taxation is wider in scope, can provide for public, pooled, insurance of the risks to the banking system as a whole; which was largely ignored in a run-up to the recent financial crisis. We aim to focus on the design of a bank regulatory and fiscal taxation regime that will contain the risk of a recurrence of a major financial crisis to an acceptable (above zero) level, given that there appears to be a trade off between financial stability and growth.

Financial stability is a true ‘Public Good’ in the economic sense that enjoyment of it by one person does not reduce the ability of others to enjoy it, and many or most benefit from it.  The taxpayer should thus be willing to share the costs (with shareholders and other fund providers of banks, including depositors) of providing it.  The question is: how much implicit insurance of big banks the taxpayer can reasonably be expected to provide, and how much bank shareholders and customers should be expected to contribute in order to reduce the risk of a crisis to an acceptable level.

If too big or systemically important to be allowed to fail banks are permitted to continue to exist, they will be implicitly insured by tax payers and able to raise funds more cheaply than smaller banks. This will give them an advantage over potential competitors.

  • Should they be required to hold more capital and liquidity reserves than smaller banks (even though they can generally diversify their risk more effectively)?
  • Should they instead be taxed more heavily and should the tax be on profits or bonuses, or related to their funding gap (between assets and retail deposits), or in some other way?
  • Should their products and services be subject to a Value Added Tax (VAT) or a Financial Transaction Tax (FTT)?

The appropriate mix of regulatory taxes (e.g. capital and liquidity requirements) and fiscal taxes also needs to be carefully considered to avoid double or over taxation.  Wholesale deposit funding by banks attracts a higher Bank Levy in the UK, but will also lead to higher liquid reserve requirements under incoming prudential regulations, and it should also be recognised that deposit insurance schemes provide means for pooled risk-related insurance funded by banks.


Theories and Methods

Special bank/financial taxes initiated and proposed in various countries will be reviewed, as will the chances for an internationally agreed tax regime. The IMF produced a report on special bank taxes for the Financial Stability Board in 2010 and dialogue with its authors and other experts will be sought using a workshop scheduled for 27 March 2013 (see below).

Current tax rules encourage excessive debt because of the tax deductibility or ‘expensing’ of interest on debt, in contrast to the non deductable the costs of servicing equity finance linked to, arguably already ‘double taxed’ dividend payments. Tax expensing should perhaps be removed to give debt equal treatment with equity, at least for banks. Furthermore, we will review capital gains tax and corporate tax reforms necessary to reduce distortions. The emphasis is on fairness and consistency of treatment throughout. This may well require differential taxation of banks that are implicitly subsidised by taxpayers and any bias towards over using of financial services and debt to be removed.

The Parliamentary Commission on Banking Standards has been appointed by both Houses of Parliament to consider and report on professional standards and culture of the UK banking sector in order to learn lessons about corporate governance, transparency and conflicts of interest, and their implications for regulation and for Government policy. The Parliamentary Commission on Banking Standards has also appointed a panel to look at tax, audit and accounting. This workstream is listening to the discussions of various experts with a view to gaining insights on taxation.

The European Commission is considering a Financial Transactions Tax (FTT) and is supported by the Liikanen Report; the UK also has a stamp duty on the sale of shares and property. However, the ‘Mirrlees Review’ of the UK tax system and the recent ‘Henry review’ of the Australian tax system both counselled against transactions taxes because they are economically inefficient, and instead advocate VAT (called GST in Australia). Currently, financial services are exempted from VAT, meaning that banks cannot reclaim input tax paid on their purchases. This puts banks at disadvantage and might lead them to take excessive risk in search of profits by engaging in such activities as the miss-selling of Payment Protection Insurance (PPI)  and manipulation of LIBOR.  VAT (GST) is economically more efficient, but operationally difficult to implement. We wish to explore whether or not financial services should cease to be exempted from VAT. With the removal of exemption from VAT, a burden has to be borne by the final consumers, but this more equal treatment might reduce wasteful usage of financial services. We are reviewing documents and comparing and contrasting practices in various countries (especially New Zealand, Australia, and South Africa, which seek to apply VAT/GST to financial services).


Workshops and Meetings

On the 27th March 2013, the tax workstream of the FinCris project will run a workshop in Birmingham on ‘Taxing Banks Fairly’. In this workshop, we wish to seek views on the appropriateness of bank taxation in the light of the financial crisis and particularly the relationship between regulatory taxes on risk taking and revenue raising taxes (special levies, stamp duties and financial transactions taxes, VAT, and CGT, income and corporation taxes) and the appropriateness, especially for banks at the base of leveraging, but perhaps not for SMEs, of the tax expensing of interest on bank debt (and the appropriate treatment of the costs of servicing equity financing).

A subsequent seminar involving tax experts will then be used in October/November 2013 to disseminate our findings.


Work Done So Far

Andy Mullineux has published a paper entitled: ‘Taxing Banks Fairly’ in the ‘International Review of Financial Analysis’, and a working paper ‘Banking for the Public Good’ on the topic. Both papers are available below:

Andy Mullineux presented his paper entitled “Banking for the Public Good” in 25th Australian Finance & Banking Conference, organised by the Institute of Global Finance and the School of Banking & Finance at the Australian Business School (ABS), UNSW, Sydney, Australia, in December 2012. A link to his presentation can be found here.

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