Cyprus Deposit Tax Sets Dangerous Precedent

April 2, 2013

Recently, Cyprus made a deal with the European Central Bank (ECB), European Union (EU) and the International Monetary Fund (IMF), the trifecta referred to as the "Troika." As part of the deal, Cyprus will come up with part of the €10 billion rescue package by taxing deposits, a move that will intensify the recession, says John Makin, a resident scholar at the American Enterprise Institute.

  • Cyprus will "restructure" its banking system by taxing deposits over €100,000.
  • The tax will intensify the loss of confidence in Europe's already shaky banks, especially in Portugal, Spain, Italy and Greece.

The Troika told Cyprus' president that €5.8 billion would have to be levied on depositors in Cypriot banks or the nation's two banks would be allowed to fail. If the banks fail, €68 billion would be wiped out, €42 billion of which is held by Cypriots and €26 billion by foreigners.

  • Most of the foreigners who hold deposits in Cyprus' banks are Russian, many of whom launder excess cash due to Cyprus' generous tax system.
  • The stringent tax on depositors to raise €5.8 billion follows the Troika giving hundreds of billions of euros in bailout funds to keep Greece afloat.
  • The financial backing of the Troika has not revitalized Greece, whose economy and stock market are still in a state of collapse. This has been disastrous for Cyprus, which invested heavily in Greece.

A tax on deposits is dangerous because it threatens people's trust that bank deposits are safe. During the U.S. financial crisis, the government guaranteed all deposits above the normal $250,000 amount. In Europe, the guaranteed amount is €100,000.

  • With the rumor of a 10 percent tax, most depositors will naturally rush to a bank and attempt to empty their account, which creates a run on the bank.
  • When bank don't have enough cash reserves on hand, banks close and individuals and businesses don't have enough money to make payments. Cash hoarding then begins.
  • The deposit tax in Cyprus is particularly worrisome because it signals to the rest of the European Union that a dangerous precedent has been set.

The deposit tax amounts to fraud and reveals the immense danger the European Union's banking system is still in.

Source: John Makin, "The Extreme Dangers of a Deposit Tax," American Enterprise Institute, March 24, 2013.

 

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