Finance
Higher taxes or lower expenses?
![Higher taxes or lower spending?](https://blogaid.org/wp-content/uploads/2024/08/Higher-taxes-or-lower-expenses.png)
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.