The Lib Dems want to tax the banks more – is this a good idea?

bank buildings

Banks make money in two ways: interest income from investments (including mortgages and other loans) and income from non-interest activities (and sometimes a little trading income). (Pexels photo)

The Liberal Democrats were the first party to unveil their manifesto and the first party to break ranks and announce tax increases, or something like that. Ed Davey announced that they would roll back tax cuts for the banks and introduce a windfall tax on profits. It is clear that the Liberal Democrats can do this because they have little chance of a majority. But does it make sense?

As we have seen with recent inflation, the Pavlovian response of Western governments and central banks is to raise interest rates to encourage saving and reduce spending.

This depends on the population being in debt: increase interest rates and reduce disposable income because people have to pay off their debts. This reduces expenses and encourages savings.

The average debt including mortgages per household in Britain is £64,296. Collectively, the people of Britain owe almost £2 trillion. Interest rate increases harm the population because they lead to much higher mortgage costs.

In the current environment we face inflation caused by higher supply costs, i.e. prices driven up by restrictions due to the war in Ukraine (spike in fuel prices) and Brexit (labor shortages driving up wages ).

According to the Office for National Statistics, average weekly wages for workers in Britain increased by 6% excluding bonuses and 5.9% including bonuses in the first quarter of 2024 compared to the previous year.

This growth reflects a continued trend of rising wages across sectors, fueling inflation. The Lib Dems clearly see political mileage in attacking the banks and, depending on the level of tax raid against them, it could be both a vote-winner and help provide the necessary funding for the NHS and public services. But does Davey’s proposal go far enough?

The two major parties continue to tell the public that they can address major concerns with NHS funding (the Nuffield Trust reported last year that there could be a £2 billion black hole in the NHS finances and the reported shortfall in the public finances up to £12 billion), without increasing tax. This will reportedly be achieved through an increase in economic growth, but that seems unlikely given the modest forecasts of less than 1% per year and the promise to pay down and reduce public debt.

Raising interest rates is a policy strongly entrenched in political ideology. Banks make money in two ways: interest income from investments (including mortgages and other loans) and income from non-interest activities (and sometimes a little trading income).

Rising interest rates will also automatically boost banks’ profits and have the knock-on effect of higher shareholder returns, either through dividends or share price increases. There will also be an increase in these banks’ tax returns, but the Liberal Democrats clearly don’t think this will be big enough.

This may be because profits at the major British banks have been quite eye-catching since the interest rate rise began. Barclays, NatWest and Lloyds are three of the largest banks in Britain. Adding up their pre-tax income in 2020, before interest rates started to rise, and comparing this with 2024, after interest rate rises took hold, shows they shared a combined profit increase of almost £18 billion. Even taking COVID into account, this is a surprising increase.

Increased taxes

Raising taxes as a method of managing economic stability, rooted in the principles of functional finance – where the government intervenes in the economy to reduce instability – offers a compelling alternative to raising interest rates.

This never plays well in the popular media, perhaps because of its heyday in the 1970s. But you could start cutting interest rates by 1% again, cutting household debt payments and boosting investment, while countering inflationary pressures by plundering not just bank profits from the past four years but also income taxes to increase slowly.

Research from HM Revenue and Customs shows that every 1% change in the basic tax rate will save the government more than £7 billion, while increasing higher tax rates by 1% would save £1.75 billion. By raising taxes and cutting interest rates to 1%, rather than increasing bank profits which are unlikely to be reinvested in UK plc, tax revenues will boost government funds that could be used for the NHS, education, infrastructure and public sector debt.

The right policy mix can stimulate economic growth and investment, while maintaining fiscal discipline and keeping inflation under control. The exact outcomes will depend on the extent to which consumers and businesses respond to these changes, as well as the general economic climate and global conditions.

The Lib Dems may be on to something, and it is encouraging to see at least one party in this election campaign challenging conventional economic wisdom on government spending, budget deficits and the role of fiscal policy in managing the economy stilt. This approach could revolutionize economic management, paving the way to a fairer and more prosperous future.The conversationThe conversation

Robert Webb, professor of banking and applied economics, University of Stirling and Duncan Watson, professor of applied economics, University of East Anglia

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