The bank levy is a highly complex and distortive tax which serves no purpose other than raising money from banks – and there’s a much better and more efficient way to do that, without any loss of revenue. Time for it to go.
I’m keen to identify taxes that don’t serve a purpose, don’t raise much money (or can be easily replaced) and add nothing except complication and economic distortion. The first was stamp duty. The second is the bank levy.1I’d love to hear more ideas on pointless taxes that should be abolished. The only rule is that, given the current state of the public finances, the tax must either raise zero revenue, or be easily replaced by a simple expansion of an existing tax.
We create taxes for a variety of reasons. For example:
- Most obviously: to raise money. But we want to raise money in the simplest and least economically distorting way that we can. Better to have one tax which raises £10bn than ten taxes, each raising £1bn
- Fairness/redistribution. We often (but not always) want a tax to be mainly paid by those with more income/assets.
- To discourage behaviour that we regard as undesirable and/or ensure the person responsible bears the cost. Many activities have a “negative externality” – they impose costs on third parties for which no compensation is paid. For example, creating pollution. A good answer is to create a tax (a “Pigouvian” tax) which will hit (in this case) the polluter and ensure the cost of the pollution are visited on it. Perhaps the polluter won’t pollute; but if they do, we now have enough tax to clean it up.2Obviously real-world examples aren’t as neat We’re correcting a market failure.
- To protect other taxes. For example, most economists agree that taxing capital gains is inefficient. The problem is that, if we don’t tax capital gains, people will use various tricks to shift taxable income into capital gains. So we have a capital gains tax – but its primary purpose is really to defend income tax. 3Another more pure example is the diverted profits tax, which was designed as the “Google tax” to punish Google for its international tax structuring. The intention is that the tax is so horrible that people would change their structure, and pay more corporation tax – and nobody would actually pay diverted profits tax. It did not work out like that.
After the financial crisis, there was a general desire for more bank taxes. There were at least three purposes – governments needed money, it felt fair to tax/punish the banks, and we could try to discourage behaviour which (it turned out) had had a very large negative externality.
The bank levy emerged from all that.
In concept, it’s very straightforward. Banks caused the financial crisis by having out-of-control balance sheets, with too many short-term liabilities. So we should tax balance sheet liabilities (excluding equity and “tier one” capital), taxing short-term liabilities more than long-term liabilities. Simply tot-up the balance sheet, and apply a percentage tax to it. That all sounds simple and very rational.
In practice, not so much:
First, that was a terrible explanation of the financial crisis, or at least a terribly incomplete one.
A better explanation: loose monetary policy leading to a housing market bubble and poor quality lending (residential and corporate). Then complex financial instruments created out of that poor quality lending which created risks that were not correctly priced/understood, and ended up being widely disseminated in non-transparent ways across the financial system. All being leveraged up thanks to the loose monetary policy.
A good answer (at least to the lending, financialization, transparency and leverage elements) is better regulation.
Tax is not a good answer, particularly when it only very vaguely relates to the actual causes of the GFC. It’s doubtful that the bank levy, or anything like it, would have changed the outcome of the financial crisis one iota.4More generally, we should be very cautious about jumping on tax as a solution to complex problems (outside of Pigouvian cases, where we can price an externality and then apply a tax to it)
Second, the incentive doesn’t work
A four-word summary of the cause of the financial crisis goes “banks bought risky assets”. But the bank levy creates no disincentive on buying risky assets. It actually creates an incentive to buy high-risk assets.
Why?
- I’m a bank. I raise £1bn of short-term liabilities to buy some extremely low-risk assets, giving me an annual profit of £2m (on which I’m taxed at 25%5Yes, the rate isn’t right, but it makes the numbers easier). The bank levy is charged at 0.1% of the £1bn liabilities. My effective tax rate on the profit is therefore 75%.6i.e. £2m x 25% plus 0.1% x £1bn = £1.5m tax in total, divided by the £2m profit. This is a very simplified example, and I’m ignoring the regulatory capital cost entirely, as well as the way liabilities are determined for UK branches of foreign banks, but I’m aware of cases alarmingly like this in the early 2010s. In one instance the bank discovered, after the event, that the bank levy ended up giving them an effective tax rate of over 100%. Most banks ended up building systems to ensure this couldn’t happen by accident.
- I’m a more aggressive bank. I raise the same £1bn but use it to speculate wildly and buy risky assets, earning an annual profit of £100m. The bank levy is still 0.1%. My effective tax rate is 26% (Total tax is £100m x 25% plus 0.1% x £1bn = £26m, divided by £100m profit)
That’s a very strange incentive.7The bank levy rules are kludged so that the really low-risk stuff (e.g. government bonds) doesn’t have this effect, but other low-risk commercial activity absolutely does.
Third, the rules are horrendously complicated
The bank levy is 36 pages of legislation, two sets of regulations, and an impressive 137 pages of guidance.
This understates the problem. Banks, particularly international banks, are very complex beasts, and applying the bank levy consistently to their assets and liabilities turns out to be really hard.
Probably the hardest technical problem I ever saw as a tax lawyer involved one paragraph of the bank levy rules. No caselaw. No pages of dense interweaving legislation. Just one paragraph. The bank levy is so obtuse that in practice most people follow HMRC guidance and ignore the legislation. No tax should work that way.
This all means that banks have had to create, and constantly update, highly complex systems to manage and report their bank levy liabilities. The rules are so complex and uncertain that the cost of this is significant, even for the largest banks. Worse, the nuances of the bank levy, particularly around hedging, can nudge banks into structures that aren’t economically efficient.
Fourth, the bank levy is anti-growth
The bank levy only applies to bank balance sheets over £20bn. On the face of it, this shouldn’t deter a bank from growing above £20bn, because only liabilities above £20bn get taxed (i.e. it’s not like the infuriating way stamp duty land tax used to work, where if you got a penny over one of the thresholds, absolutely everything became taxable at a higher rate).
But the complexity of the bank levy, and the need to build/maintain/manage complex systems means that, if you’re a foreign bank with a branch in London, reaching £20bn of liabilities is highly undesirable. The way liabilities are calculated for branches means that, to control the branch-allocated liabilities, you have to control the branch assets – in other words, prevent the UK branch from growing. The unpredictability of exchange rates and asset prices means you’ll want to be a comfortable distance off £20bn.
There’s also the human factor – do you want to be the bank executive that approves growth above £20bn, and sign off on all the compliance and system costs the bank levy then requires, only to look a right Charlie a year later when the balance sheet drops below £20bn and it turns out to have all been a big waste of time?
I’m personally aware of two cases where foreign banks took significant decisions to redirect growth away from London – because of the bank levy. There are likely many more.
Fifth, if we want to tax banks, there are better ways
How about just making the banks pay a higher rate of corporation tax?
We did that – it’s called the bank surcharge.8I also have problems with the surcharge – there are better and less distortive ways to tax banks. But it’s a whole lot better than the bank levy It’s a fairly simple tax – an additional percentage on top of normal corporation tax. The rate used to be 8% and is now 3%9Because the surcharge was created to prevent banks getting any benefit from the cut in corporation tax down to 19%, so it’s rational to partially reverse it when corporation tax rates go back up to 25%
Why have both the bank levy and the bank surcharge? Unclear.
So what’s the answer?
It’s easy. Repeal the bank levy.
That would create about a £1.5bn hole in government revenues.
Fortunately, there’s an easy way to fill it – just raise the bank surcharge back up to 8%.10The bank surcharge raised about £2.4bn when it was 8%. So, in broad terms, we can abolish the bank levy, and raise an additional £1.5bn from the surcharge by taking the rate back to 8% i.e. because 3% + (1.5/2.4 x 8%) = 8%
That should be revenue-neutral overall for the Government (plus some small cost savings for HMRC, likely around £10m11HMRC report the average cost of administering the tax system is 0.5% of taxes collected; the bank levy probably costs rather more than that to administer, given the small number of taxpayers (and so no economies of scale), but I’ll use that figure in the interest of prudence. On the other hand, adding 5% to the bank surcharge should not add any material administration cost for HMRC).
It would be revenue-neutral for the UK bank sector overall (but with some significant administrative/systems cost savings, probably approaching seven figures for the larger banks).
There would be winners and losers as between different banks. Broadly, lower risk/lower return banks would benefit, and higher risk/higher return banks would lose out (i.e. because of the shift to taxing profits). We might see potential losers lobbying heavily against any change. That shouldn’t stop us. But, having spoken to people within the industry (including two heads of tax at large banks), my feeling is that even the “losing out” banks may welcome the simplification.
There aren’t many opportunities to abolish an entire tax, and nudge UK tax policy in a pro-growth direction, at no net cost to the Exchequer. This is one – we should take it.
Thanks to all the bank people who spoke to me about this.
Image by Stable Diffusion – “tangled ball of string, insanely detailed”
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1I’d love to hear more ideas on pointless taxes that should be abolished. The only rule is that, given the current state of the public finances, the tax must either raise zero revenue, or be easily replaced by a simple expansion of an existing tax.
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2Obviously real-world examples aren’t as neat
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3Another more pure example is the diverted profits tax, which was designed as the “Google tax” to punish Google for its international tax structuring. The intention is that the tax is so horrible that people would change their structure, and pay more corporation tax – and nobody would actually pay diverted profits tax. It did not work out like that.
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4More generally, we should be very cautious about jumping on tax as a solution to complex problems (outside of Pigouvian cases, where we can price an externality and then apply a tax to it)
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5Yes, the rate isn’t right, but it makes the numbers easier
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6i.e. £2m x 25% plus 0.1% x £1bn = £1.5m tax in total, divided by the £2m profit. This is a very simplified example, and I’m ignoring the regulatory capital cost entirely, as well as the way liabilities are determined for UK branches of foreign banks, but I’m aware of cases alarmingly like this in the early 2010s. In one instance the bank discovered, after the event, that the bank levy ended up giving them an effective tax rate of over 100%. Most banks ended up building systems to ensure this couldn’t happen by accident.
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7The bank levy rules are kludged so that the really low-risk stuff (e.g. government bonds) doesn’t have this effect, but other low-risk commercial activity absolutely does.
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8I also have problems with the surcharge – there are better and less distortive ways to tax banks. But it’s a whole lot better than the bank levy
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9Because the surcharge was created to prevent banks getting any benefit from the cut in corporation tax down to 19%, so it’s rational to partially reverse it when corporation tax rates go back up to 25%
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10The bank surcharge raised about £2.4bn when it was 8%. So, in broad terms, we can abolish the bank levy, and raise an additional £1.5bn from the surcharge by taking the rate back to 8% i.e. because 3% + (1.5/2.4 x 8%) = 8%
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11HMRC report the average cost of administering the tax system is 0.5% of taxes collected; the bank levy probably costs rather more than that to administer, given the small number of taxpayers (and so no economies of scale), but I’ll use that figure in the interest of prudence. On the other hand, adding 5% to the bank surcharge should not add any material administration cost for HMRC
One response to “Pointless taxes that should be abolished #2: the bank levy”
Another great article. During my career, I have frequently seen the unintended negative consequences of poorly designed legislation, especially in financial services, acting as a disincentive to investment and growth. On the other hand, the cost of banks’ risk, compliance and IT functions have grown exponentially. I am not sure this is the “growth” that the government was aiming for! Perhaps we should be even more radical and simplify the UK tax framework by looking at the HK or SIngapore models as a guide.