There are several principles at stake in the row over Cyprus and its bailout. But one we should ignore is the hysterical reaction to a tax on bank deposits. It is a wealth tax — and about time too.
Russia's president, Vladimir Putin, is outraged and so are all Europe's banks. Writing in the Financial Times, Mohamed El-Erian, of investment firm Pimco, represents the widely held view that it is the thin end of the wedge. What next? Spaniards will worry that a bailout, which many believe inevitable, will come with a current account surcharge attached.
But Cyprus is a special case. It is completely bankrupt. It has strung out negotiations with Brussels and the International Monetary Fund (IMF) for months. It has taken those negotiations to the brink with an insistence that it receive the same treatment as Ireland and Portugal, who received loans and were allowed to determine how they repaid them.
Giving loans to Cyprus presumes that the country has the capacity to repay. It should do, but it doesn't. It has one of the highest per capita GDP ratios in the Mediterranean. It is a huge centre for ship management, and a haven for English and Russian tourists. And it has developed a huge financial centre relative to its size. Yet there is a suspicion that most of the funds in the country are only there if this tax haven remains just that. And, like Greece, corruption is a factor.
Any long-term effort to repay European Union loans will be left to ordinary people while the rich take flight. A direct tax is necessary. It could take the form of a cut on incomes. That is the policy pursued in Ireland and Portugal, where public sector workers took the hit. But the Cyprus per capita income figure hides huge disparities.
Wealth disparity
Again, the rich would hide and the poor would pay. A wealth tax on bank deposits, where most wealth is held, is consequently a practical solution that also fulfils a basic economic need, which is to shift taxes away from income to wealth. Poorer citizens need to feed themselves and a tax on incomes, especially for those with no savings, is the worst outcome.
The IMF, the London-based Institute for Fiscal Studies, and Paris-based think-tank the OECD, have argued that governments need to switch away from taxes on incomes, which act as a disincentive to work, to taxes on wealth. They sensibly target land. Unfortunately, a tax on land takes time, which Cyprus doesn't have.
There was a route to avoid this debacle. The EU, after the financial crash, should have agreed to forgive much of the debts. The Germans, who are blocking debt forgiveness, would have been repaid in full from economic growth over the past three years. Instead, they face a prolonged depression and growing resentment from southern Europe towards their hardline policies.
To offset some of the burden, the EU should exclude the smallest savings deposits from the tax. But given the constraints, it's easy to see why the Cypriots were ambushed, and why a wealth tax became a key element of the package. — © Guardian News & Media 2013