Wednesday, March 20, 2013

The United States Bank Deposits Tax

The  bank deposit tax that the European Central Bank (ECB) wants Cyprus to levy on its bank depositors in return for a financial bailout of its banks has sparked a lot of outrage.  The proposal would have resulted in a 9.9% tax on large deposits (over 100,000 euros) and a 6.5% tax on smaller deposits (less than 100,000 euros). It has also raised the question as to whether such a tax could ever be initiated in the United States.  Most say it could not happen here. 

The fact is that we already effectively have a United States Bank Deposits Tax.  It is the Zero Interest Rate Policy (ZIRP) of the Federal Reserve.

In Cyprus, depositors have recently been getting an interest rate of 4.66% on their equivalent of a one-year certificate of deposit.  That compares to a .26% average annual yield that U.S banks are currently paying on a one-year CD.

The average rate for CD's in the United States since 1984 is 4.09% which is not far off of the current Cyprus rate.  This chart gives you an historical perspective of CD rates since 1984.

What I find interesting is the almost universal outrage about the ECB's attempt to tax the Cyprus bank depositors to pay for the bail out of their banks while the same thing has been going on in the United States with the ZIRP policy with nary a peep from anyone.

The bank depositors in Cyprus have been earning what historically has been considered a fair return on their savings and now the ECB wants to impose a tax on the savings deposits.  In Cyprus, depositors have had the ability to make a return on their savings of almost 5% before the tax is imposed.  In the United States, due to the Fed's ZIRP, the depositors are getting almost nothing.  There is no need for the deposit tax because, in effect, bank depoistors have already been paying for the bailout of the U.S. banks with the foregone interest on their savings.

In the final analysis, there is almost no difference between what is being done with United States bank depositors compared to what is proposed in Cyprus.

What I find most interesting is the vastly different reactions to the two scenarios.  There is outrage over Cyprus but almost total acceptance in the United States (and other countries that have adopted ZIRP) of what could be considered a 4% indirect tax on bank deposits.

Why is that?

I believe the answer lies in how the human brain sees things.

It is generally very hard for the human brain to process anything but direct effects.  We have a hard time in dealing with one-offs, especially when it comes to money.  It is easy to understand when money has been taking from me directly.  It is harder to understand when I end up in the same place but the money was taken from me in an indirect way even if I end up in the same place.

The best example of this is how inflation can erode the value of money.  I cited the work of Daniel Kahneman, Richard Thaler and Jack Knetsch on this subject in my post "The Money Illusion" two years ago.  KTK did a lot of research on the subject of "fairness".  When did people think something was fair or unfair.  I think their research explains a lot about the different reactions we are seeing between Cyprus and the United States ZIRP.

One survey question in the KTK research presented these facts to individuals.

A company is making a small profit.  It is located in a community experiencing a recession with substantial unemployment but no inflation.  There are many workers anxious to work for the company.  The company decides to decrease wages and salaries 7% this year.
Notice how this meant that each worker has lost 7%.  62% of respondents deemed this unfair.

Another version of the question had the exact facts but inflation was stated to be 12% and the company was going to limit salary increases to 5%.  
This scenario puts the workers in exactly the same place.  They have lost 7% of the value of their money.  However, 78% of respondents thought this was fair.

The perception of fairness was completely different even though the end result was exactly the same.

The Cyprus bank deposit tax is yet another example of the dangerous times we live in.  Government policymakers will do almost anything to save their own hides.  They will delay, defer, deceive and disassociate all they can.  The ECB policymakers made a mistake here in that they embarked on a direct attack on depositors when they should have settled for an indirect attack.  Why did they just not force the Cyprus banks to a zero interest rate policy and get their bailout money that way?  They totally misunderstood human psychology.

I will close the same way I did two years ago in "The Money Illusion".  The Cyrpus bank deposit tax example is instructive because it shows the sharp contrast on how not to do something as a government policy maker when it is  relatively easy to steal the public blind if you just take the more indirect paths of ZIRP and inflation.

The lesson here for all of us is that we need to be very careful.  Inflation is the easiest policy option for government to solve its debt problems.  It is a lot easier to inflate the currency to wipe out its debts than to take the pain of spending restraint.  It is also the easiest way to hoodwink the public.  It just does not feel like you are losing.  Receiving a 2% social security increase when prices are rising 10% just doesn't seem to feel as bad as having your social security payment cut by 5% when inflation is 2%.   You are actually better off with the 5% cut from a buying power perspective.  However, KTK's research shows what the public will think is "fair" and "unfair".  

The same goes for ZIRP.  People don't like getting 0% on their money when they are used to getting 4%.  However, they haven't taken to the streets in outrage.  They would if they had to pay a 4% tax. It just seems worse to have to pay a 4% bank deposit tax (even if you are also earning 4% interest) than to just get 0% on your deposit.  When you pay something directly you really feel the loss.  

Beware the "Money Illusion" and policy makers who think they are magicians. Watch your wallet.

1 comment:

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