The Federal Reserve has been raising interest
rates as part of its strategy to combat inflation. Consequently, this has led
to increased interest rates on various types of loans, including mortgages, car
loans, and credit cards. In response to the US Federal Reserve's actions, the
Central Bank of Jordan (CBJ) has also raised interest rates on all monetary
policy tools. The CBJ's decision aims to uphold the monetary and financial
stability of the Kingdom of Jordan. Additionally, it seeks to enhance the
competitiveness of assets denominated in Jordanian Dinars by maintaining an
appropriate interest rate structure that aligns with recent global and regional
interest rate trends.
اضافة اعلان
In 2023, the Italian government introduced a
one-time windfall tax of 40 percent on banks. This specific tax targets the
substantial profits that banks have generated due to rising interest rates.
The rationale behind this tax
The rationale behind this tax lies in the
argument that banks have reaped excessive profits from these rate hikes. This
arises from the fact that banks typically pass on only a portion of the
interest rate increase to savers while charging borrowers higher rates. As a
result, banks have witnessed a boost in profits, while savers have experienced
diminished interest earnings. The government's objective in implementing this
tax is to provide assistance to individuals grappling with the escalating cost
of living. The generated tax revenue will be utilized to implement measures
that aid individuals in managing their mortgages and other debts.
A conversation about additional taxes on the
profits
Consequently, a discussion has emerged
advocating for additional taxes on the profits banks acquire through elevated
interest rates during the tax year 2023. This stance hinges on several factors,
including Jordan's specific tax laws, the quantum of banks' profits, and the
consequences of interest rate hikes on their financial performance. Firstly,
banks stand to gain windfall profits from elevated interest rates, as they
charge borrowers more without reciprocally raising deposit interest. This
dynamic effectively transfers wealth from borrowers to banks.
While raising interest rates can help contain inflation, it can also yield adverse outcomes such as hindering business growth and consumer affordability. For example, banks creating loans essentially introduce new money into the economy, which, when utilized to purchase goods and services, can stoke inflation.
Secondly, it is observed that banks
contribute to inflation in various ways. Higher interest rates increase the
cost of borrowing for both businesses and consumers, potentially curbing
economic activity and exacerbating inflation. Banks can also directly foster
inflation by expanding the money supply through loans, generating excess money
in circulation. This can heighten demand, leading to price inflation. Moreover,
banks can indirectly contribute to inflation by enabling increased business
borrowing, which stimulates investment and production, subsequently driving inflation.
It can also yield adverse outcomes
While raising interest rates can help contain
inflation, it can also yield adverse outcomes such as hindering business growth
and consumer affordability. For example, banks creating loans essentially
introduce new money into the economy, which, when utilized to purchase goods
and services, can stoke inflation. Additionally, loans to consumers amplify
money circulation, promoting increased consumer spending and contributing to
inflation. Furthermore, banks' investments in assets like stocks and bonds can
inflate their prices, thereby adding to inflationary pressures.
The argument continues by emphasizing that
banks are already highly profitable entities. In 2022, the average profit
margin of Jordanian banks stood at 17.3 percent, surpassing the global average
of 13.9 percent. Noteworthy banks in Jordan with high profit margins included
Arab Bank (23.4 percent), Housing Bank for Trade and Finance (20.2 percent),
Bank of Jordan (18.1 percent), and Jordan Ahli Bank (17.6 percent). In
contrast, the United States saw an average return on equity for banks at 10.6
percent in 2022. This rate notably exceeded returns in other industries. A
study by the Institute of Taxation and Economic
Policy disclosed that the top five US banks
paid an effective federal income tax rate of merely 6.6 percent in 2020,
significantly below the statutory federal corporate tax rate of 21 percent.
Additionally, these banks paid an average effective state and local tax rate of
just 1.2 percent.
The argument gains further traction by
highlighting banks' utilization of tax avoidance through insuring bad debt
returns. These loans are reinsured with international insurance firms. When
these bad debt conditions align with amounts designated as bad debts in the
bank's annual budget, the compensation policy is invoked to secure the agreed
insurance coverage. Nonetheless, banks continue pursuing debtors for these
amounts despite claiming insurance allowance. The tax accounting exemptions on
insured bad debts are exploited, allowing banks to simultaneously claim debts
and sue debtors.
However, the windfall tax proposal has faced
criticism from certain economists who contend that it could discourage lending
and potentially slow down economic growth.
Valid counterarguments
Therefore, valid counterarguments come into
play. Firstly, implementing the proposed tax would necessitate amendments to
income tax laws, making it possible for banks to modify lending practices to
evade taxes. Secondly, the tax could discourage banks from lending, as the
anticipation of extra taxes on their profits might dampen their willingness to
extend loans to businesses and consumers.
This could hamper economic expansion.
Thirdly, it might be deemed unfair to levy additional taxes on banks, as their
rate adjustments are primarily reactions to market dynamics. They are operating
within legal and ethical bounds, though there has been increasing pressure in
recent years to subject banks to higher interest rates in response to their
record profits and perceived insufficient contributions to the economy.
However, the windfall tax proposal has faced criticism from certain economists who contend that it could discourage lending and potentially slow down economic growth.
However, it is vital to acknowledge that
banks aren't the sole contributors to inflation. Other factors like supply
chain disruptions and rising energy costs also play significant roles. Banks,
nonetheless, wield considerable influence over inflation and can significantly
impact the economy. In the current climate of escalating inflation, banks find
themselves navigating a delicate balance. They must elevate interest rates to
temper economic activity and mitigate inflation while avoiding rates that could
impede business growth and consumer affordability. The intricate interplay
between these factors will shape banks' strategies moving forward, with
far-reaching consequences for the economy and inflation.
Underscores the inherent risk
Additionally, the discussion underscores the
inherent risk within banks' lending activities. These institutions undertake substantial
risks when extending loans, potentially incurring significant losses if loans
turn bad. This risk factor contributes to the high profit’s banks are able to
generate. Moreover, banks' societal value is highlighted, as they are pivotal
in providing loans to both businesses and consumers, facilitating transactions,
and payments.
The complexity of the issue
Examining the potential consequences of
imposing higher taxes on banks further illuminates the complexity of the issue.
Banks might offset the tax increase by raising fees and interest rates,
impacting borrowers and potentially slowing down the economy. However, the
broader economic conditions and borrower riskiness are also significant factors
influencing banks' lending decisions. Furthermore, the government could tailor
the tax to target specific bank activities rather than a blanket approach to
lending.
Ultimately, the impact of higher taxes on
banks' lending practices hinges on numerous variables and is challenging to
predict definitively. In general, while elevated interest rates can boost
banks' profits by allowing them to charge more for loans and financial
products, they can also escalate costs by necessitating higher payouts on
deposits and funding sources. The net effect of these interest rate increases
on Jordanian banks' profitability remains uncertain. The decision to levy
additional taxes on banks for profits accrued from increased interest rates is
intricate, involving well-founded arguments on both sides. It's a decision that
necessitates thorough consideration of all pertinent factors. Ultimately, the
choice to raise taxes on Jordanian banks in the 2023 tax year is a political
one, requiring the government to weigh potential revenue gains against
potential ramifications for the banking sector.
Dr. Hamza Alakaleek is a Corporate lawyer and
tax consultant with post-graduate degrees in international political economy,
international business law, and law and technology with a focus on internet of
things, artificial intelligence and data protection.
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