Higher taxes or lower spending? – Econlib

Consider the following thought experiment. The government imposes a tax of $1000 on all bankers. One the very same day, the government authorizes a new spending program, a $1000 subsidy to all bankers. How should we think of this combined policy? To me, it’s a nothingburger.

Economists used to view reserve requirements as an implicit tax on banks.  That’s because in the old days there was no interest paid on bank reserves, so there was a high opportunity cost of holding reserves.  

Now, we have no reserve requirements, but we do pay interest on reserves (IOR).  This was done because policymakers wished to move to a “floor system”, where banks would choose to hold large quantities of reserves.  The adoption of IOR allows the central bank to inject lots of reserves into the system, without driving interest rates down to zero.   You can think of large reserve holdings as a tax on banking, and IOR as an offsetting subsidy.

Chris Giles has an article in the FT where he suggests that the BoE move to a system where the tax is maintained but the subsidy is removed:

The central bank pays 5.25 per cent on reserves so that it can set the short-term policy interest rate at that level. It is effective, but not the only way to control short-term rates.

Instead, it could require banks to hold a fixed amount of money without interest, paying 5.25 per cent only on a small part of the reserves.

I don’t like the idea of paying interest on reserves, but I also oppose reserve requirements.

Go back to the thought experiment at the top of this post.  Suppose the government suddenly removed the $1000 subsidy to bankers, but kept the $1000 tax in place.  How should we think about that change?  In a technical sense, it involves a cut in government spending.  But it also moves us from a situation where there is no net flow of money to or from bankers, to a situation where all that remains is a $1000 tax on bankers.  That feels like a tax increase.

Giles views things differently:

One difficulty is that Andrew Bailey, BoE governor, still needs to be persuaded. In 2021 he said the policy would be a tax on banking. The truth is that it would lower public spending.

The “truth” is that truth is a slippery concept, especially where terms are poorly defined.  I understand Giles’s point, but I find Bailey’s characterization to be closer to my way of viewing things.  You would be essentially forcing banks to lend lots of money to the British government at a rate of zero percent.  That seems like the imposition of a tax on banking.