Why every bank will soon be a tax collector for every government everywhere

Financial repression. A few years ago when a few people (Gillian Tett, Russell Napier, etc) started predicting that it would be the thing that made our crisis go away, not many were convinced. The phrase refers to the various methods that hideously indebted governments use to channel the money knocking around an economy to itself rather than anywhere else.

It can include anything from capping interest rates on government debt or deposit rates (as seen all over the world at the moment); forcing institutions to buy government debt; or, at its most obvious, putting in capital controls to prevent anyone taking their money out of the country.

All these things have the same effective result: by taking away other investment options they allow governments to issue sovereign debt with much lower interest rates than they would otherwise be able to. That brings down the cost of debt nicely. But if you then chuck in a little inflation you can make the real value of the debt come down too. Keep that up for a couple of decades and you can repress your way out of trouble. 

This, of course, is exactly how many countries dealt with their horrible post-war debts: let’s not forget that the UK was subject to capital controls until 1979. However, even a few years back, there was a general view that in our new deregulated world, it wouldn’t be possible for governments to use these time-tested methods to get themselves out of trouble. Turns out that it is entirely possible. As Edward Chancellor pointed out in the FT, even in a time of apparently free capital movement, financial repression is entirely possible if everyone does it at the same time. 

And doing it they are. “Negative real interest rates are to be found not only in the US but also in China, Europe, Canada and the UK”, where headline inflation is running at 3.4%, “far above both short and long-term interest rates… Western governments have learnt the lessons of history”, so they are all maintaining interest rates at levels well below inflation. At the same time, inflation is pushing up nominal GDP, and will in time “reduce the real value of outstanding debts, both public and private”. 

But the authorities aren’t leaving it there. Far from it; they are going for more explicit repression as well. At the same time, everyone is pushing for their banks to hold more debt for “macro prudential reasons”.

And even when regulation isn’t actually put in place, political pressure is. An article in the Wall Street Journal late last year noted that “senior bank executives” from Italy and Portugal said they were being cajoled into buying government debt.  Last year, the idea started circulating in Ireland that pension funds should be forced to sell foreign assets and buy Irish government debt. It makes no sense, said one commentator, that pension funds should hold bunds yielding 2-3% when they could hold Irish debt on 6-10%.

Hmmm. This year, Irish prime minister Enda Kenny is about to make it “easier” for pension fund managers to shift from bunds to Irish debt – by transferring the risk of holding it from the pension fund to the pensioner. Hungary has gone the whole hog and annexed pension funds. In 2010, for example, in an effective nationalisation of their private pension fund system, Hungarians were told to hand their private pension fund assets to the state or lose their state pension.


And capital controls? The idea sounds extreme to modern consumers, but they are certainly back under discussion (see Gillian Tett on them), and you could even argue that, in some ways, they are already with us.

Those who work in the investment business will know of a new US regulation known as ‘Fatca’ (Foreign Account Tax Compliance Act). Fatca is an extraordinarily wide-ranging, arrogant and intrusive piece of legislation (enacted in 2010) that requires all “foreign financial institutions” – that’s non-US banks, fund managers, custodians and so on, to tell the US taxman about all US taxpayers they deal with both directly and indirectly by the middle of next year.

This is quite clearly an admin nightmare (what is an ‘indirect client’?) so you might think that most non-US institutions would simply ignore it. After all, what jurisdiction does the US have over them? You’d think wrong. No one can ignore it: if they do, the Internal Revenue Service (IRS) will charge them a 30% withholding tax on all dividends, interest and sales proceeds made in the US.

The tax will begin to be deducted at the beginning of 2014. There will be no refunds. Failure to comply will also be a criminal offence under US law. How is this repression? It makes it harder for US citizens to invest abroad – already institutions, wary of the fact that they aren’t or can’t be compliant, are turning down US business until they see how the whole thing shakes down (how can you find out all you need to about all your clients and ‘sort of clients’ without running into confidentiality problems, for starters?).

The whole thing very dramatically changes the investing and tax landscape for Americans with money abroad. Worse, the crazy US rules won’t be the end of it. No, read this piece by William Hutchings in Financial News, and you will see that Fatca is about to go global.

“In the last three years, the Federal Reserve, Bank of England, European Central Bank and Bank of Japan have taken on an extra $10 trillion of debt, according to risk management consultancy CheckRisk, taking their collective balance sheet to $15 trillion.

“They are looking at every possible way to help pay it off. Ramping up their powers of tax collection is one of the few things they can do to help themselves. It is not such a big jump from there to the introduction of a global Fatca, an international framework obliging foreign financial institutions everywhere to act as tax collector for every government.”

John Redwood pointed out in his blog this week that the UK state is currently spending around 48% of GDP a year. Yet the maximum ever tax take is 38%. The gap has to be made up by someone – just as it does in every other Western country.

Financial repression creates that someone – by making a population hold debt that loses them money in real terms be it via their pension funds or banks, by cutting the return they get on their deposits, by upping their taxes and by letting inflation chip away at their assets. That someone is you.

  • Jon

    If i were a debt ridden UK Government looking to lay my hands on cash, i would be looking to sequestrate the billions of pounds ‘handed over’ to pension savers in the form of contracted-out rebates – they’ve already declared contracting out via moneypurchase schemes to be ceasing next week, thus cutting further outflows from the Government, so reclaiming those past flows is just one small step away.

    This would be an easy sell; the rebates come from the NI contributions of todays workers, which would otherwise be spent on the benefits promised to todays pensioners, such is the Ponzi that is Government finances.

    So, cash outflows are cut, borrowing to pay todays benefits is cut, and once sequestrated, overall debt reduced too.

    Dont believe it will happen ? Check out the recent financial wizardy surrounding the Royal Mail pension scheme.

  • distressedman

    OK all banks in the world will them report all bank accounts of Americans. But, there are Americans who live in the USA and have foreign bank accounts and there are Americans Living Abroad who by necessity must have their money in “foreign” bank accounts. But there are more, greencarders living in the USA who have bank accounts back home even before they moved to the USA. Are they all be treated the same? And suppose all countries start doing the same with the USA. How many greencarders and dual citizens live in the USA and have US bank accounts? I al curious to see how this will evolve.

  • nobledreamer

    Green card holders and even immigrants in the US with accounts “back home” will be treated the same. It is beyond reasonable. Some who entered OVDP in 2009 and opted out had to deal with a 2-year timeframe before it was over. Most US expats abroad have been unaware of their filing/reporting requirements; we imagine the green card holders and immigrants are even less aware. It is appalling how IRS takes no responsibility for notifying anyone and then expects compliance with draconian and onerous penalties. What a mess.

  • Just Me

    Carl Levin created FATCA. The IRS responded with the domestic version DATCA requiring US banks to turn in their non resident customers to the IRS, and now, the world is moving towards the global FATCA or GATCA, if you will. Of course, no one knows for sure what the consequences of this will be for the world economy, but it can’t be good.

    The US launches its unilateral economic FATCA drones and never recognizes the collateral damage when it happens. This is going to do some serious harm to US expats abroad, cause a lot of capital to flee America all because Carl thinks some Rich in the homeland are evading taxes. Well, guess what Carl? They still will evade taxes after your global FATCA is created, and all the rest of us will suffer. Meantime you will retire with a big lobbying job in DC and never return to Michigan to see the negative impacts of your actions when Canadians pull their money out of US banks.

  • Segedunum

    Yep, I’m afraid the only way they know how to save their economies is by……….taking more tax from ordinary people who actually create wealth in the economy, thus pulling the chain on the economy still further. It becomes impossible to do business.

    1, Jon: Yep, it’s one of the reasons why I stopped paying into my pension scheme and why I’m glad I don’t have a lot in there. The games that will be played with pension schemes are going to be nasty. I’m nowhere near retirement age either and it is highly likely my retirement age will be after I die, which is obviously what they’re gunning for. They just want to be left with a massive pension pile they can play with. It’s not what I work every month to have happen.

  • chris

    #5 Call me jaundiced and cynical but I suspect that the UK Government is actually quite happy to see 125,000 people a year die of smoking related illness if the majority actually die before they retire and claim their state pension. I wonder if anyone has the figures for the average age at death of a smoker? From their point of view I imagine it would be ideal if the smoker paid NI all his life and died just before or slightly after retiring. Or even drinking too. Nice bit of tax on the sale of alcohol and tobacco and then no need to pay out a pension later too. Only thing left would be to make it impossible for the NHS to pay for self inflicted illness.

  • DRS

    1. Poor people benefit from state services and will continue to struggle on.
    2. Rich people will be more affected by all these measures and have the legal means to dodge and weave.

    However, the levels of government debt are in a “bubble” that will have to burst.

    What are investors to do?

    >>>>>>I think a balenced portfolio is best and holding some cash to invest in new INTERNET-BASED companies after the next crash (when many of the older, traditional “Brick and Morter” companies will be killed off.)

    As for real assets: Pick ‘n mix as one sees fits (regarding prices).

    Oh, and don’t forget elderly/deathcare investments as populations get older.

  • grp

    Withholding tax is already occurring. In October 2010 we held bonds with Goldman Sachs 5.5%2021 issue all in an ISA.

    The Prospectus for the original issue of quite clearly states that interest shall be paid without the deduction of withholding tax and that in the event that tax is withheld then Goldman Sachs will pay an increased coupon so that the net of tax payment shall equal 5.5%.

    This is what happened -refer to my broker’s note below

    They paid gross; then debited US WHT; then repaid the US WHT, and then debited the US WHT again. And all over an extended period.

    That much is clear and known.

    On the last debit, Crest declared to me directly – well there “Operational Team”, that said they were speaking to their corporate action team, that this now “was it”, final, definitely subject to the suffering of 30% US WHT.

    Story closed according to them,

    Withholding tax has been here for nearly 2 years!!