Financial Tax Reform: The Money Creation Tax

Abstract

Researchers have renewed the case for an alternative view of how money is created. Rather than viewing a bank as receiving deposits which form the basis for its lending activities, the traditional view of banking, researchers are demonstrating that banks first grant loans, thereby initiating the money creation process. Commenting on this alternative view, Mario Bin Draghi, President of the European Central Bank, writes that the next paper will contend that banks are to pay taxes on their money creation. This is that paper. Earlier calls and proposals for financial tax reform have been made. Revenue-oriented financial tax proposals include a financial transactions tax, a financial activities tax, a financial services contribution, a bank employee bonus tax, and a bank credit seigniorage tax, while corrective financial taxation proposals include a bank default rate tax, a financial market or risk-based tax, a non-core liabilities tax, and a debt-bias tax. A money creation tax, having its roots in the bank credit seigniorage tax, is new. We examine the role of both the central bank and the commercial banks in the money creation process. The money creation process consists of the central bank’s ability to print physical currency and commercial banks’ ability to grant loans. Beginning with central banking, we review opportunity cost seigniorage and monetary seigniorage, and find that the average annual monetary seigniorage from 2004-2014 for the U.S. Federal Reserve was $54.1 billion. We argue that the tax base of monetary seigniorage be net income, and that the monetary seigniorage tax rate be 99%, because the Federal Reserve operates as a monopoly to print physical notes on behalf of the U.S. government. For commercial banks, we compare how credit money is created in the traditional model (the base reserve multiplier model), and the alternate (credit counterparts) model. Empirically, there is mixed support for both models. Nonetheless, in both models, we show it is the commercial banks that create credit money through loans, with the central bank influencing this process. Empirically, we find that the average annual net credit money created for all U.S. banks from 2004-2014 was $340 billion. The interest and fees on credit money (i.e. loans) for all U.S. banks from 2004-2014 was $380 billion, while profitability on money creation, as proxied by average annual net interest income, was $354 billion. We argue that the tax base of credit money seigniorage be net interest income, and that the credit money seigniorage tax rate be one-third of the monetary seigniorage tax rate, that is, 33%. This amount is still less than the highest corporate tax rate of 35% for taxable income greater than $10 million.