Confusion and Conflation

by George Hatjoullis

English: Cyprus map with Cyprus government logo.

English: Cyprus map with Cyprus government logo. (Photo credit: Wikipedia)

The situation in Cyprus seems to have confused all the smart people in the world because they have conflated a tax event with a credit event. Insured bank deposits are protected against credit events. A tax event is not a credit event. The Cyprus government has chosen to recapitalize banks via several new wealth taxes. One such tax is to be levied on wealth held as cash deposits in all Cyprus banks (whatever the financial condition of the bank) last weekend. The equity arising through the recapitalisation will be distributed pro rata to the cash deposit tax payer. Other wealth taxes have been imposed on immovable property. These have not been commented upon.

In the UK the government recapitalize the failing banks via general taxation. The equity arising is owned collectively by all tax payers. However, they will benefit pro rata if and when the equity is sold at a profit.

The specific form of tax (on cash depositors) was forced upon the Cyprus government by Germany. The purpose of Germany was to penalize alleged illegally acquired wealth held in the form of cash deposits in Cyprus banks. The German government did not suggest the tax be levied on all cash deposits. The distribution was and remains the decision of the Cyprus government. The fact that the Cyprus government chose to penalize all depositors reflects the fear that it would damage its offshore banking business if only large depositors were to be penalised. It may need to modify the distribution to get parliamentary approval. The IMF was motivated by the need to ensure that the rescue put Cyprus on a sustainable debt path. A wealth tax of some form was thus arithmetically necessary.

The fact that a government has taxed a specific form of wealth insured against a credit event has caused a lot of nonsenseĀ to be written. The only precedent that has actually been set is that all forms of wealth (including the shirt on your back) is a legitimate target for tax. But this is not a precedent, it is a reminder.

There are times when i despair.