IMF warns that extraordinary taxes on banking and energy should be limited and temporary…

    EL PAÍS BY ANTONIO MAQUEDA, MADRID - JUNE 17, 2024 - ENGLISH EDITION BY GERMAN & CO.

The International Monetary Fund (IMF) warns Spain that extraordinary taxes on banks, energy companies and large fortunes should be “limited and temporary”. These have raised significant revenue, some 3.5 billion euros in the 2023 fiscal year, and have helped finance measures to combat the energy and price crises, the IMF admits. However, the Washington-based institution considers that these taxes, if maintained in their current format, could be “particularly distortionary and create uncertainty”, which in turn “could discourage investment that is already weak”.

The Fund explains that these taxes were introduced in response to the inflationary crisis triggered by the war in Ukraine: “The question of who should bear the cost of the measures came to the fore,” it notes. In this context, energy companies have benefited from soaring prices. And banks have raised their margins with the rate hikes that were approved to tame inflation: they have passed on the rates to the loans they grant, but they have not passed them on with the same intensity to their depositors. This is the conclusion of a study by the Bank of Spain that quotes the IMF. All this has justified the government’s reaction. However, such exceptionality cannot last forever: “Extraordinary levies do not constitute a growth-friendly fiscal consolidation strategy”, say the Fund’s economists in their annual report on the Spanish economy, the so-called Article IV. They add that they are not a sound alternative to measures that raise revenues in a structural way. In the long term, revenue collection should be complemented by initiatives to contain the increase in spending, especially on pensions, they conclude.

If such levies are to be made permanent, the IMF explains, the windfall gains should be clearly defined. It would be advisable to align the tax bases with that definition to minimise distortionary effects, it says. They could also be redesigned to pursue other objectives: according to the Fund, the bank tax could be reoriented in such a way that the accumulated countercyclical capital buffers can be deducted. In fact, the Bank of Spain has just demanded an increase in these buffers because it believes that now is the time to build up their reserves.

In other words, the tax could be used to make banks better capitalised. Banks in Spain have low levels of capital in European comparison. Although they would hold up well in an adverse scenario, they would do so at the cost of a substantial contraction in credit, according to the stress analysis carried out by the FMI. “A retention of banks’ profits today could pay off if risks materialise,” he says. So using the tax to shore up capital would be a way to strengthen the financial system and prepare it for future crises. This position of the IMF is the same as that of the Bank of Spain.

The government has announced its intention to make these figures permanent. It will use them to justify to Brussels that it is approving the fiscal reform it has committed to in exchange for European funds. When asked if she would allow capital gains tax relief, María Jesús Montero replied that the tax is designed to raise revenue and not to improve the solvency of banks. The Treasury did allow renewable investments to be deducted in the tax on energy companies after negotiating with the PNV.

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The tax on banks is 4.8% of the net interest and commission income of institutions operating in Spain with revenues of more than 800 million euros. The IMF recalls that the ECB has already criticised it. On the basis of 2022, 1.2 billion was collected. According to the Fund’s calculations, this represents 10% of the profit linked to its activity in Spain in 2023: “A fairly small fraction but not trivial”. “Although it does not seem to have had a significant negative effect on the financial sector, its magnitude is sufficient to influence future decisions of banks if it is prolonged,” the report states.

In the agency’s view, the design of the tax has “important limitations”. It taxes net interest income and not profit. As a result, it does not take into account the possibility that banks may have high margins but low profits, and vice versa. “Risky lending could be particularly disadvantaged, as its higher returns would be taxed while its higher provisions would not be deductible,” notes Kristalina Georgieva’s institution. Still, it acknowledges that identifying windfall profits is not easy: Spanish banks’ return on equity did not experience significant increases compared to their European peers in 2022 and 2023. However, profitability in the domestic market increased to its highest level since the financial crisis, due, according to the Bank of Spain, to the fact that they returned less on deposits than in the euro area and other periods with similar economic conditions. The 800 million limit leaves out institutions regardless of their profitability, it adds.

The IMF considers that only cyclical factors should be included in the tax base, which would lower the revenue raising capacity. In any case, even without the redesign, the Fund expects its revenues to decline in the coming years as margins narrow because rates are lowered and because they are passed on to depositors.

The energy levy…

The extraordinary tax on energy companies is 1.2% of their turnover. In 2023, 1.6 billion was collected for the 2022 activity. The Fund recalls that several of these companies threatened to take their investments to other countries if the levy was extended. It has been extended until 2025. But it was announced, following an agreement with the PNV, that investments in renewable energy projects will be deducted. However, as there is no budget, these deductions are not in force.

Like the banking tax, the energy tax does not necessarily capture companies’ profits and lacks a clear definition of excess profit, says the Fund. As it does not differentiate between types of energy, it cannot be considered an environmental tax. However, it concedes that the green investment deduction can function as an incentive. Like the bank levy, the energy levy should be time-limited under the current design, it stresses.

If made permanent, the tax should stick to a clear definition of excess profit rather than on the operating balance sheet, he stresses. And this definition should distinguish between those high profits that are due to externally driven price fluctuations and those that are inherent to domestic market competition. The former are the ones that should be taxed, it argues.

Moreover, the IMF says that Spain already stands out for its wide variety of energy taxes.

such as VAT, production tax and special electricity tax, among others. The interaction between all taxes should be taken into account, he argues. If taxation is restricted strictly to those profits that are not due to competition, revenue will fall. In any case, it will go down as energy prices have normalised.

Tax on large fortunes…

On the other hand, the IMF analyses the solidarity tax on large fortunes announced in December 2022. It explains that wealth taxes can be an instrument to raise revenue and to achieve redistribution. But he points out that if the differences in the tax are very large between regions, it can also have distortionary effects: it could lead to residency decisions dictated by taxation. And if wealth tax is left at the state level, it clashes with the autonomy of the communities. Cooperation to establish a minimum wealth tax is a more viable way forward, it concludes.

The report highlights that of the 623 million raised in 2023, 555 million came from the Community of Madrid, which historically has not taxed wealth. And it recalls that this autonomous region has announced a change in the tax to redirect revenues to the regional government and, in return, has communicated a series of tax benefits to compensate high net worth individuals, such as tax incentives to create companies, invest or hire in the region. It is initiatives would disable net revenue collection, he warns.