Update: Boom! With 36 votes against, the Cypriot legislature nixed the deposit tax. Let’s see if the alternative is any kinder to ordinary Cypriots. And if foreigners take out their cash anyway when banks reopen.
Every nation, no matter how small, eventually gets a minute in the spotlight. Usually it’s not for good news. So it with Cyprus, where the plan to pay for a bailout by taxing bank deposits has elicited outrage among everyone from Cypriot citizens to Vladimir Putin to kibitzers who could barely find Cyprus on a map.
The photos of long lines at empty ATMs haven’t been great PR for the government of Cyprus or for European policy-makers. Nothing says Coming Depression as crisply as a bank run. The early consensus is that taxing bank deposits shakes the very core of the financial system.
Economist Tyler Cowen says this could go down as a blunder of historic proportions. At Reuters, Felix Salmon notes that the vow that your bank deposits are safe is one of a government’s most important promises. “Botched and improvised,” is how one expert characterized the plan to Bloomberg’s James G. Neuger. The only people who don’t seem to hate the plan are those who are just left speechless. The New York Times’s Paul Krugman confesses he didn’t see it coming — a moment for the record books.
This wasn’t a well-thought-out plan. Nonetheless, it’s worth considering whether what Cyprus is doing is worse than what other governments have done in similar circumstances. There’s a case to be made that (a) for most Cypriots it beats the alternatives and (b) a devastating run on the banks as soon as they reopen isn’t the sure thing many commentators assume.
Ultimately, taxing bank deposits (or, as Caroline Baum at Bloomberg View says, “confiscating” them) has many of the same effects as a currency devaluation. Whether the devaluation happens overnight, as it did in Argentina in 2002, or over an extended period of inflation, the ultimate hit to savers of all kinds is the same as a tax on deposits.
Devaluation has always been the final, and often not-so-final, resort of governments unable to pay their debts. In the euro zone, it’s no longer an option. But a deposit tax punishes savers just as a devaluation would. By taking money out of the economy, it makes Cypriots relatively poorer, and less able to afford goods from abroad, (eventually pushing the balance of payments in favor of domestic industry: the upside of devaluation).
These are the same effects as Cyprus would face if it left the euro zone — except that would be a much, much bigger and more sudden shock. Citigroup estimated last year that Greece would face the equivalent of a 60 percent currency devaluation if it got kicked out of the zone. You can assume that the consequences for Cyprus would be similar. By that standard, the deposit levies that Cyprus is considering — whether 9.9 percent or 6.75 percent — are a bargain.
So why the outrage? I would venture to say that the real difference between the bank levy and other solutions is that the levy is transparent and obvious, while the wealth effects of devaluation or inflation are hidden.
That would seem to be an argument for the levy, except that optics do matter in these cases, and, as Cowen notes, there seems to be great resistance to a transparent wealth tax. It’s possible that cutting the rate on smaller deposits, something that Cyprus is already contemplating, could remedy that.
That finally brings us to point (b): An immediate general run on the banks isn’t the certainty the empty ATMs might suggest. Of the 40.1 billion euros in deposits at Cyprus’s banks, 8.8 billion euros — about 21 percent — are immediately redeemable. If you look only at the 30 billion euros in household (ie. non-business) accounts, the share is even lower. The rest is tied up in time deposits of up to two years.
That means that if Cyprus goes through with the tax on deposits, there’s plenty of opportunity to cool off before every penny gets pulled out of the banks. Yes, foreign depositors, including the oft-mentioned Russian oligarchs, will pull out their money. But with the shakiness of the Cypriot financial system, you can bet that was going to happen anyway.
Given the choice of a tax on wealth or half-baked European austerity measures to achieve raise the same 5.8 billion euros, TMN would be inclined to go with the deposit tax. At Marginal Revolution, Tyler Cowen says the tax reflects the deeply anti-democratic impulses of European policy-makers. It doesn’t take a Machiavellian command of politics to see that taxing bank deposits isn’t an easy sell to voters anywhere. Fair enough.
But at least with a bank deposit tax, Cypriots get to see exactly what money is getting taken from them and where it’s going. That’s more than can be said for most other austerity plans.
Update, March 19: The bank levy now looks like it won’t pass the Cypriot legislature, even with the sweetener of exempting deposits under 20,000 euros. That would mean no deposit tax revenue — while very likely still leaving plenty of foreign depositors jittery enough to withdraw their money at the first opportunity. It seems to me that means much of the pain, and none of the benefit. That’s happening just as a few commentators seem to be turning around on the plan. Andrew Ross Sorkin at the New York Times also defends it, and points out that despite dire predictions, there’s certainly no Europe-wide bank run. That said, if you want to recap all the mistakes that policy makers have made in the last days getting to this point, and all the ways this makes Cypriots feel their national policy has been hijacked by Germany, make sure to read James G. Neuger’s masterful story about the negotiations.