Don't tax savings!
Filed under: Investing
Some estimates put the cost to borrowers since 2009 at £470bn, more than the £325bn injected into the economy by the Bank of England.
Your guide to banking
Need to know: Savings
But the irony is this. The present crisis was caused by uncontrolled, debt-fuelled consumption: all of us spending what we didn't have, encouraged by irresponsible politicians and bankers on both sides of the Atlantic. Gordon Brown's promise of 'no more boom and bust' was a call to arms comparable to Lord Cardigan's charge at Balaclava.
The real solution to the crisis is austerity: a decade or so of scrimping and paring expenditure so we can pay back our debts. Quantitative easing (QE) may be a necessary sticking plaster to keep the economy going, but it's certainly not the solution.
Your guide to banking
Need to know: Savings
But shouldn't policy makers give some thought to the structural issues that lay behind the crisis? Should they, perhaps, learn a lesson from the savings culture of China while taking its money to bail out their own debt-ridden economies?
One way governments can influence behaviour is through the tax system. So here's my proposal:
- Remove tax on savings (i.e. interest income).
- Remove (or cap) the tax break on business borrowing.
Allowing savers to keep interest gross would:
- Immediately help those who rely on savings income and who have suffered worst from QE, especially pensioners and the elderly. That's the issue the Treasury Select Committee wants the government to address.
- Encourage a culture of saving, something this country lost in the decades from 1970 to 1990. In the war of the generations, those who claim the baby boomers have put housing out of the reach of younger people forget that, before the 1970s, it was necessary to build up a record of saving with a building society before you could ask to borrow. That culture of having to save to spend has been lost.
- Bring onshore money that the rich currently save in offshore tax havens, and channel more money into the productive economy rather than tax avoidance schemes.
- Put more stable retail deposits onto the high-street banks' balance sheets.
That last point is crucial. Symptomatic of the high-octane debt dependence that created the financial crisis was the greater reliance of banks on cheaper but more volatile wholesale funding, epitomised by the disastrous Northern Rock.
The whole panoply of complex savings products could be simplified. With a little encouragement from the regulator, more of peoples' savings could go onto banks' balance sheets as retail deposits. Banks know all about the inertia of retail depositors.
That would enable commercial banks to rediscover their traditional role of maturity transformation, and so lend more to the productive economy, more cheaply and more safely.
More, better bank lending would be vital to implement my second proposal, to remove (or cap) the tax shield on business borrowing to pay for the first measure.
Arguably, it is a distortion that debt finance is tax deductible for businesses. It shows most clearly in the highly leveraged private equity deals that have enriched deal makers since the 1980s, stripped countless companies of their cash flows and, ultimately, pushed many into administration with tragic loss of jobs.
Of course, private equity ownership has in many cases injected financial and commercial discipline into companies and so benefited the economy. But the use of high leverage is entirely ascribable to the tax deductibility of debt, and fundamentally has no economic benefit other that the transfer of wealth from taxpayers and the target company to the new owners.
More generally, there is no doubt that the tax benefit is a strong incentive for corporate treasurers to borrow. It would be better for companies to determine their optimal capital structure without tax distortions.
Behaviour would evolve to match the circumstances. Without the tax shield it might, for example, become more common for a company to finance investment with convertible debt, paying a relatively high interest cost at first but being rewarded with fresh equity if the investment produced share price growth. Existing shareholders would bear such dilution if the share price rose.
Certainly, it's a good time to implement such a change. With companies' balance sheets stuffed with cash, the short-term impact would be muted.
Except, perhaps, for small-to-medium enterprises (SMEs). It would obviously be wrong to suddenly bump up their borrowing costs. They have enough problems as it is, and don't have the resilience of larger companies. So maybe the tax shield should be capped rather than removed altogether.
But removing the tax deductibility of borrowing should put pressure on banks to reduce the cost of their loans. They have the headroom to do so. The latest Bank of England credit conditions survey reveals that SME loan rates have barely moved since 2008, during which time the bank base rate has dropped from 2% to 0.5%.
The bigger issue is availability of credit, which the boost to bank balance sheets from retail deposits should help.