ALTERNATIVE APPROACHES TO TAXING THE FINANCE SECTOR: WHICH IS BEST ?

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ALTERNATIVE APPROACHES TO TAXING THE FINANCE
SECTOR WHICH IS BEST ?

• Patrick Honohan
• World Bank
• Financial Sector Policy Global Dialogue
  SeriesApril 2, 2003

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Easily raised, widely diffused, pressing little
on any particular class, especially the lower
orders of society, and producing a revenue safely
and expeditiously collected at a small expense
William Pitt, Chancellor of the Exchequer,
announcing a doubling of Stamp Duty in 1797
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Main types of financial sector tax

• Explicit
• Implicit

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Explicit taxes

• Levied on many elements of an FIs business e.g.
  
• Profits,
• Gross revenue (interest and fees)
• Value of payments made through the intermediary
•  Interest paid to depositors/creditors (including
  withholding)
• impact may differ compared with same tax on
  nonfinancial company

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Implicit taxes

• On liabilities
• Reserve requirements
• Seigniorage
• On assets
• Directed credit
• Interest ceilings

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Two perspectives on reform

• The big idea
• Versus
• Focus on market failure

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The big reform ideas (flat tax)

• Capital income should it be taxed at all?
• Taxing financial services can a VAT work?
• Transactions taxes panacea or Pandoras box?

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Corrective taxes

• Deposit insurance supposedly helps stability,
  but maybe outweighed by the induced moral hazard
• Provisioning and capital adequacy
• Promoting saving
• Etc.

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Vulnerability to arbitrage and inflation-proneness

• The systems capacity for arbitrage
• Sensitivity to inflation

 
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Lessons

• Each of the big ideas has lessons for a good
  system.
• VAT on financial services represents a useful
  benchmark.
• Significant financial transactions taxes hard to
  justify use only as a transitory device under
  pressure.
• Avoid heavy emphasis on the taxation of income
  from capital.

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Lessons (continued)

• Arbitrage-proof the system (defensive criterion
  1).
• Inflation-proof the system (defensive criterion
  2).
• Corrective taxation view with skepticism
• Calibrate the burden in an appropriate way