The tragedy of Cyprus
Back in 1941, with the memory of the Great Depression still weighing heavy, an American wrote into the Federal Reserve with an idea. “Would it not be feasible,” the member of the public asked, “to impose a Federal tax on the deposit of funds in bank checking accounts?”
The reply from the Fed was polite but succinct: while there’s no doubt a tax on bank deposits would have “the advantage of administrative simplicity”, it is “not in accord with one of the fundamental principles of taxation in a democracy, namely, that taxes should be imposed in accordance with ability to pay”.
And that, when it comes down to it, is the most scandalous and worrying aspect of the overnight decision to impose a one-off levy on all bank deposits in Cyprus. There is no doubt the country is in big trouble: it was heading for a potential default and is in desperate need of another bail-out. However, trying to recoup some of the cash directly from bank deposits is a step across the financial Rubicon. Even in the depths of the euro crisis, none of the troubled countries had, until now, gone so far as to confiscate bank deposits. As the Fed said all those years ago, doing so involves arbitrary charges on those least equipped to afford them.
And so it will be in Cyprus. If you have anything up to €100,000 in a bank, by the time you next get access to your account on Tuesday (there’s a bank holiday on Monday) some 6.75% of your cash will have disappeared into the Government’s coffers to help keep the country afloat. That goes for everyone, from a pensioner to a small business owner to a millionaire (although Greek depositors get an exception). If you have more than €100,000 the charge is 9.9%.
In exchange, Cypriots will get a share in the relevant bank, equivalent to the value of the tax deduction – although this is unlikely to be of much consolation given the country’s current financial woes.
To make those distributional consequences even more egregious, the word from Brussels is that while depositors will get hit, the senior creditors who own bonds in the banks (including, naturally, some of the racier hedge funds) will escape scot-free.
The concern isn’t merely about the brutal arbitrariness of the plan – it’s about its implication for the country’s financial system in the coming months. There are scant examples of similar bank levies, but those that there are are hardly shining models. In July 1992 Italy’s Socialist Prime Minister Giuliano Amato imposed a one-off levy on bank accounts. It was a mere 0.6% in comparison with Cyprus’s scheme, and it still left a lasting scar on the country’s financial psyche. In 1936 Norway experimented with a bank deposit tax, but it caused an exodus of cash from the country. There are also some Latin American examples (Brazil in 1992, Argentina at the turn of the millennium) but most were combined with capital controls, and were last-ditch efforts to rescue the financial system when all else had already been tried.
There really is no precedent for a policy of this sort, on this scale, and in an economic system where there are no controls on the movement of cash from one country to another, which leads one to believe that it will trigger depositors to pull money out of Cyprus at record speed as soon as they have the chance.
Moreover, given that this policy was not merely rubber-stamped but engineered by Eurozone finance ministers and the IMF (indeed, the IMF wanted an even deeper cut of deposits), it sends a disquieting message to anyone with deposits in a euro area bank. Although the ministers were quick to insist that this is a one-off and is “exceptional”, anyone even vaguely acquainted with the initial Greek bail-outs will remember precisely how long such exceptions last.
Now, to some extent, one can see the logic in the plan. The country has an enormous banking system, worth several times more than its economic output. Around half of all those deposits (estimates vary) are owned by Russians, many of whom allegedly use the country as a tax haven from their own domestic charges. Another hefty chunk of the bank deposits are owned by Britons – although UK deposits in UK branches and subsidiaries won’t be affected. This one-off levy will at least recoup some of the cash needed for the bail-out from these depositors rather than the Cypriot taxpayer.
And why should the Russians (primarily) and the British (less so) have to contribute to a bail-out simply because Germany was unwilling to pay up? The pragmatic answer is that conveniently they weren’t in the room when the move was negotiated. Germany, which let’s not forget has an election later this year, was.
Or, in the words of someone closely involved with the negotiations: “Basically Cypriots turned their country into an offshore tax haven for dirty Russian money and the Germans and others are now insisting they pay the price for that.”
However, that price is a deeply socially-damaging one.
The move has all sorts of implications, whether it’s for the state of the euro crisis, the prospect of future assaults on bank deposits, and the British deposits in Cypriot banks, which will now be gouged for the bailout. However, most of all, one’s sympathy has to be with the country’s savers. Consider it: overnight a widow’s life savings, carefully saved up over decades, have been gouged, simply because EU bureaucrats decided to protect hedge funds and the German surplus, and to teach Russians a lesson.