The 2017 Commonwealth Budget proposed to introduce a levy on some deposits of the five large banks from July 1, 2017. The levy is expected to collect about $1.5 billion a year. While the banks will write the cheque to the government in the first instance, ultimately the levy is passed on to individuals. Bearers of the levy could come from: lower returns to shareholders in the banks; bank customers paying higher fees and interest rates; and, lower remuneration for bank employees and in particular bank executives. This article describes the different paths for final destiny of the levy, and the more likely outcome.
While many would like to believe much of the bank levy would be absorbed as a reduction in the remuneration paid to bank executives, this outcome is very unlikely. Personnel selected to run the five large Australian banks are drawn from a very much larger pool of people to run other Australian large companies, and finance and other companies across the globe. That is, the large Australian banks are price takers in a large global market when it comes to the relevant supply of, and the remuneration level for, skilled people.
In essence the proposed bank levy is a tax on a specific and key input required by the large banks, namely wholesale deposits. A combination of factors and experience support the argument that most of the input tax will be passed forward to bank customers as higher prices in the form of higher fees and interest rates to borrowers.
First, given that Australia is both an open economy and a relatively small player in a much larger global capital market, the supply of wholesale market deposits to Australian banks is highly elastic, meaning Australia is a price taker. Second, for various reasons Australian bank customers are reluctant to change banks with the result that extra costs can be passed on without losing many customers. Sure, the smaller banks, and maybe international banks, not subject to the levy will receive a competitive advantage and gain some market share, but only a small proportion of customers will switch from the large banks. Third, and reinforcing the second point, for consistency of logic that the five large Australian banks have oligopoly power, or cartel-like behaviour, most of any general cost increase, including the proposed bank levy, will be passed forward to buyers of bank services. Fourth, a long history of Australian banks passing forward both higher and lower interest rates set by the Reserve Bank of Australia to their customers provides empirical support for the logic that most of the levy will be passed forward to customers. Studies of the effects of similar levies imposed on European banks in the post-GFC period find the levy is passed forward to borrowers (for example, Kogler 2015).
Then, with the bank levy flowing through to higher costs for borrowed funds, much of the final or economic incidence of the bank levy will be borne by household and business borrowers.
If government was to argue that the levy is a crude way of charging for the benefits of government support to ensure the continuity and reliability of the large banks during financial crises such as that of 2008, for example as explored by Ingles and Stewart, then borrowers’ extra costs could be considered a payment for the enhanced banking services.
Shareholders are the residual claimants on bank profits. To the extent the levy is not fully passed on as lower remuneration or higher customer prices, the remaining portion of the levy reduces large bank profits. In turn, lower bank profits become lower dividends for shareholders. The loss to shareholders will be partly offset as the levy will be a deductible expense in assessing corporate income tax; in effect reducing the after-tax cost from six basis points to 4.2 basis points.
A lower expected stream of future dividends will result in a one-off reduction of the share prices for owners of the large banks, and hence a capital loss for all shareholders.
Large bank shareholders are spread across the Australian community, especially when superannuation holdings are included. Also, non-residents are included in shareholders of the large Australian banks.
Both economic logic and experience indicate that most of the proposed levy on the large banks will be passed forward to the bank borrowers, both households and businesses, as higher interest outlays and fees. A small portion may be passed onto shareholders as lower future dividends leading to a one-off fall in bank share prices.
Not sure about borrowers having to bear a tax on the super-profits of banks, John. That would break the rule that revenues drawn from economic rents are unable to be passed on. Let’s see!