Levy may sting the borrower, not depositor
Treasurer Chris Bowen says he's imposing a new savings account levy on our super-profitable banks, but the banks say they'll just pass it straight on to their depositors.
Details of the levy haven't been announced, but we can piece them together. It won't take effect until January 2016, and it's expected to raise almost $750 million in its first 18 months. It will apply to all deposits of up to $250,000 in banks, building societies and credit unions.
It will be imposed at the rate of 0.05 per cent (5¢ per $100) on the balance in your account at a particular date each year. The proceeds will go into a separate "financial stability fund" until, after 10 years, the fund has accumulated an amount equivalent to 0.5 per cent of the value of all accounts guaranteed under the government's existing "financial claims scheme".
Money in the fund will be invested by the Future Fund guardians or a similar body. It can be taken out only to compensate people who've lost their savings in the unlikely event of their bank going under.
So the levy is like an insurance premium, a user-pays measure that means the banks will be paying for the benefit they receive from having the government guarantee their deposits of up to $250,000. Larger deposits will not be formally government guaranteed.
Needless to say, the banks hate the idea of having to pay for a guarantee they previously didn't have to pay for. And they've tried to gain public support by saying they'd be forced to pass the cost on to their customers.
But that's what businesspeople always say when they're fighting a new impost. As a consequence, they've spent decades inculcating in the public's mind the belief that markets are based on "cost-plus pricing".
The prices a business charges are simply a reflection of the costs the business incurs plus a margin for profit. So when a wicked government imposes a new cost on a firm, it has no choice but to pass it on. But economics teaches that cost-plus pricing is not the way markets work. That's because cost-plus focuses solely on the business's cost of supply, ignoring the role of customers' demand and their "willingness [or unwillingness] to pay".
On the other hand, economists well understand that the initial or legal "incidence" of a tax (the person required by law to write the cheque that pays the tax in to the taxman) isn't likely to be the same as the tax's final or effective incidence (the person who ends up actually bearing the burden of the tax). This is because the firm that bears the legal incidence will use whatever economic power it has to shift the burden of the tax either back to its employees or forward to its customers.
But anyone who has studied any economics knows it is unlikely to be true that all the cost of the deposits tax will be passed on to depositors. Early in an economics course you learn to test such arguments by drawing a diagram with price on the vertical axis, quantity on the horizontal axis and a supply curve sloping up to the right, crossed at some point by a demand curve sloping down to the right. The point where the two curves cross is the market price.
Shift the supply curve up to reflect the extra cost imposed on the firm by the tax and you soon see the increase in the market price is less than the amount of the tax, meaning some part of the tax has been shifted onto customers, but the rest remains borne by the firm as a reduction in its profits.
Why do firms and industries try to fight the imposition of new taxes by claiming they'll simply pass the tax on to their customers? If that's true, why are they getting so upset? Because they fear that, in truth, they'll have to bear some of the burden themselves.
It turns out that how much of the tax they can get away with passing on to customers is determined by the steepness of the slope of the demand curve, which represents the degree of "elasticity" (price-sensitivity) of the demand for the product.
When demand for the product is highly elastic (so that a small price rise causes a big fall in the quantity demanded), firms will have to bear most of the burden of the tax. Only in rare cases where demand for the product is perfectly inelastic (so that the quantity demanded is unaffected by changes in its price) will firms be able to pass on all the tax.
Unfortunately, this neat analysis - like much micro-economic analysis - is highly simplified: based on the assumption of "perfect competition". Among the many unrealistic assumptions of perfect competition, the most pertinent in our case is there are so many small sellers in the market none is able to have any effect on the price.
By contrast, banking is an oligopoly (a small number of big sellers) where each firm does have some degree of pricing power - especially when they act in concert.
But here's the trick. The banks' behaviour since the global financial crisis makes it much more likely the banks will protect their profits by passing on the burden of the deposits tax to their borrowers than to their depositors.
That's because the GFC caused the sharemarket, the ratings agencies and the regulators to pressure the banks to raise less of the funds they need from overseas and more from local depositors. Their competition bid up the "price" of deposits and they passed this increase in their "cost of funds" on to their borrowers by making "unofficial" increases in mortgage interest rates and passing on less than the full cuts in the official interest rate.
Their need to attract deposits remains, so they're likely to pass this small increase in their funding costs on to borrowers, not depositors.