The Cyprus parliament has overwhelmingly rejected the proposed bank deposit levy with 36 votes against, 19 abstentions and zero in favour.
This could well be one of the most shortsighted and ill-considered decisions for a country on the cusp of bankruptcy with chronic debt and a near insolvent banking sector. Cyprus had been thrown a life-line from the European Union, the International Monetary Fund and the European Central Bank, the so-called troika, which was a bailout package of €10 billion or around 50 per cent of GDP, but only if the government imposed a one-off tax on bank deposits.
Cyprus is thumbing its nose at this generous offer.
The bank deposit levy would have raised as much as €5.8 billion and would have seen an automatic reduction in the level of debt and open the doors for the troika’s rescue money to flow.
By rejecting the package, Cyprus is shooting itself in the foot with the fix to the budget and bailout money now in doubt.
For reasons that are not all that clear, it appears the government would prefer to raise income and company taxes, cut jobs, cut wages and impose severe austerity rather than have a one-off deposit levy. Potentially more than half the revenue would have come from foreigners who deposited money with Cypriot banks for what can only be described as dodgy reasons.
It is not clear which path the near bankrupt Cyprus will now go, but at the time of writing, it is apparent that the troika will not approve the bailout package if Cyprus does not do its bit to address its own problems. As Dutch Finance Minister Jeroen Dijsselbloem so sensibly noted, “Cyprus must contribute to its own bailout”.
Whatever the end point for Cyprus, the deposit tax has sparked what is turning out to be a very useful debate on policy.
When there are excesses in an economy that result from policy failure or laxity or corporate fraud or incompetence and there are substantial financial losses for the whole economy, someone has to pay to fix it up. It is that or the government defaults on its debt and there is a decade of financial pain as your country is frozen out of capital markets and other fiscal austerity measures kick in.
It is as simple as that.
For today’s leaders and policy makers, be they in Cyprus, Greece, Spain, Ireland, the US or the UK, it matters little who or what was the cause of those losses, but it does matter that those problems are confronted and fixed.
It is a bit like the cute Irish joke about a tourist who is in Cork and he asks one of the locals for directions to Dublin. The Irishman replies: ‘Well sir, if I were you, I wouldn’t start from here’.
It is an oldie, but a goodie.
Of course, if I were the President of Cyprus looking to qualify for bailout funds from the troika, I wouldn’t want to be overseeing a banking sector that is effectively bankrupt and have net government debt of 87 per cent of GDP and rising.
But that is the situation in Cyprus.
Something has to be done, and urgently, or else the government runs out of money, it is unable to access capital markets for years and its banking sector collapses.
In this scenario of default and bankruptcy, there would be untold misery. This would be through high and rising unemployment, falling real wages, cuts to services and wealth destruction. The effect would, almost without question, be a lot more adverse to most people than depositors having a few percent of their savings clipped from them.
It is beyond doubt that the deposit levy in Cyprus is undesirable, unfair, mean and draconian. It hurts prudent savers. It is biased against older citizens who inevitably have been building savings as they approach retirement. The profligate, the young and debtors are not financially punished. Banks and bond holders are largely unaffected.
Life is unfair.
But there is no doubt the deposit levy is quick, efficient and yields a huge, almost instant, return to the government and implicitly the banks.
The Cypriot government still needs to raise huge amounts of revenue if it is to fix its internal finances.
Without a deposit levy, there will need to be more cuts to wages, higher income and personal taxes, cuts to welfare payments, cuts to the health system, education and so on.
It seems that for most commentators and the Parliament of Cyprus, this is more desirable than a one-off deposit levy.
I am not sure why.