Higher taxes or lower expenses?

Consider the following thought experiment. The government imposes a $1000 tax on all bankers. On the same day, the government approves a new spending program, a $1000 subsidy for all bankers. How should we view this combined policy? To me it’s a nothing burger.

Economists used to view reserve requirements as an implicit tax on banks. That’s because in the past no interest was paid on bank reserves, which meant there was a high opportunity cost of holding reserves.

Now we have no reserve requirements, but we do pay interest on reserves (IOR). This was done because policymakers wanted to move to a ‘floor system’, where banks would choose to hold large amounts of reserves. By introducing IOR, the central bank can inject a lot of reserves into the system without lowering interest rates to zero. You can think of large reserves as a tax on the banking system, and IOR as a compensatory subsidy.

Chris Giles has an article in theft in which he suggests that the BoE move to a system in which the tax is maintained but the subsidy is abolished:

The central bank pays 5.25 percent on reserves so that it can set short-term interest rates at that level. It is effective, but not the only way to keep short-term interest rates under control.

Instead, it could require banks to hold a fixed amount of money without interest, paying just 5.25 percent on a small portion of reserves.

I don’t like the idea of ​​paying interest on reserves, but I’m also against reserve requirements.

Go back to the thought experiment at the top of this post. Suppose the government suddenly eliminated the $1,000 subsidy to bankers, but kept the $1,000 tax in place. How should we think about that change? In a technical sense, it involves a cut in government spending. But it also takes us from a situation where there is no net flow of money to or from bankers, to a situation where all that remains is a thousand dollar tax on bankers. That feels like a tax increase.

Giles sees things differently:

One problem is that Andrew Bailey, governor of the BoE, still needs convincing. In 2021, he said the policy would be a tax on the banking system. The truth is that it would reduce government spending.

The “truth” is that truth is a slippery concept, especially when the terms are poorly defined. I see Giles’ point, but I think Bailey’s characterization is closer to my way of seeing things. You would essentially force the banks to lend a lot of money to the British government at zero percent interest. That is akin to imposing a tax on the banking system.