By Professor Andy Mullineux
Lloyds Banking Group Centre for Responsible Business, Emeritus Professor of Financial Economics
While the cost-of-living crisis tears through the UK, consumers have faced huge changes in their mortgage rates, energy bills and grocery shopping – but banks have enjoyed windfalls borne on interest rate and tax changes. With the Autumn budget due on 17th November, what does ‘fair’ look like in regard to bank taxing and surcharges?
Back in Spring 2021, Chancellor Rishi Sunak scheduled a rise from 19% to 25% in Corporation Tax, along with a reduction in the tax surcharge paid by banks from 8% to 3%. This left banks paying Corporation Tax of 28%, rather than 27%. Fast-forward to September 2022: Chancellor Kwasi Kwartang revoked the Corporation Tax increase and the surcharge reduction was abandoned. Now, Chancellor Jeremy Hunt and Prime Minister Rishi Sunak have re-instated the corporation tax rise – but the surcharge level is uncertain, in light of banks’ windfall revenues from widening margins between the interest rates they charge for lending (including mortgages) and lower rates they pay on deposits.
The recent Bank of England (BoE) policy rate increase of 0.75% will further bolster the banks’ net interest income, and the BoE is expected to raise its policy rate further to tackle inflation. Meanwhile, the banks are benefitting from an inflow of cheap deposits as investors sell shares and bonds to avoid further losses. The banks thus have no need to raise deposit rates in line with the policy rate, despite now earning 3% on their own deposits with the BoE. They have also benefitted from the rise in mortgage rates prompted by the increase in government bond (‘gilt’) yields during the market turmoil caused by September’s ‘mini-budget’. Further, the banks will benefit from the energy price cap, to the extent that it and the energy bill assistance reduces late payments and defaults on mortgages and other loans. In sum, like the energy suppliers, the banks are enjoying substantial windfall revenues; but in early November they announced considerable increases in their provisions against expected future bad debts. After the 2007-9 financial crisis, banks took advantage of the tax rules to set their losses against future Corporation Tax liabilities and so a windfall tax could be seen as natural opportunity for them to payback to taxpayers.
The surcharge kicks in at the relatively low level of £25m and this allowance was due to be raised to £100m so that it impacted only the bigger banks; allowing ‘challenger banks’ to compete more effectively. In the revised implementation, the allowance could perhaps be set on a sliding scale favouring smaller banks over bigger ones.
Following the 2016 budget, the surcharge supplemented a special levy on certain balance sheet liabilities and the equity of big banks; with the aim of encouraging them to adopt less risky funding models and to make a fair tax contribution.
A bank levy can be seen as a premium paid by big banks for the implicit insurance they enjoy because they are too big to be allowed to fail; as demonstrated in the financial crisis. Shareholder-owned banks are special corporations because they are allowed to make profit from creating money, by holding liquid reserves that are a fraction of their loans – borrowing short term (deposits) and lending longer term (especially mortgages) and taking on the associated risks. The banking system thus needs to be carefully regulated, taking the market dominance of big banks into account. As the major suppliers of essential financial services, the big banks have much in common with other utilities, such as large energy and water suppliers, and thus have public duties and social responsibilities.
Whilst the bank levy has a clear purpose, and a windfall tax on bank profits (at least whilst their net interest income is rising) seems justifiable; the continuation of the surcharge, especially for smaller banks, makes much less sense at a time when the government is trying to bolster the competitiveness of the City. If the surcharge were to be scrapped – and it should be – a windfall tax on bank profits, at least until interest rates start to fall again, should be introduced.
Before the financial crisis, the City was a goose that laid ‘golden eggs’ in the form of substantial tax revenue. It is also a major exporter of financial services, helping to reduce the UK’s burgeoning trade deficit. However, the big banks’ cost of equity has almost doubled (to 20%) since the 2016 Brexit vote; due to uncertainty over the UK’s economic prospects – exacerbated by the Covid crisis and aggravated by the recent political turmoil. Lifting the cap on bankers’ bonuses can be seen as an attempt to enhance the attractiveness of the City to skilled bankers from abroad, and thus its international competitiveness.
Another tax the Chancellor should consider is to raise the zero VAT rate on financial services to the standard rate, as recommended in the 2011 Mirrlees Review of the UK tax system. Targeted exemptions could be considered to combat increased charges for access to cash and making payments. Another consideration perhaps is the wider use of financial transactions taxes (‘stamp duties’) and/or a financial activity tax.
In an attempt to restore stability and reduce uncertainty, the Autumn 2022 budget statement is rumoured to include a 5 year government deficit reduction plan, even though the next election is due in a little over 2 years. Whilst forward looking provisioning should be encouraged, the authorities should make sure they are not used to massage bank tax liabilities.
The bank levy should be retained at a level that assures that big banks pay an appropriate premium for their implicit insurance by taxpayers. The levy should focus on the beneficiary shareholders and other major creditors (bondholders) of banks, so that it cannot simply be passed on to bank customers.
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The views and opinions expressed in this article are those of the author and do not necessarily reflect the official policy or position of the University of Birmingham.