Government Revenue from Financial Repression

Abstract

This paper explores the theoretical underpinnings and empirical relevance to public finance of financial repression - of controls on international capital flows and on domestic financial intermediaries. It concludes, in principle, countries should not resort to financial repression when they face no constraints on taxation, but such constraints as administrative cost and income distribution objectives might justify an implicit tax on domestic financial markets. The revenue from financial repression can be substantial. The unweighted cross-country average is about 2 percent of GDP and 9 percent of total government revenue, but varies significantly among countries. Reform aimed at liberalizing financial markets should first estimate what amount of government revenue comes from financial repression and provide for the revenue shortfall that will result from financial liberalization. Finally, this paper concludes that countries with higher rates of inflation tend to raise more revenue from financial repressions because the relative costs of foreign and domestic borrowing are influenced by the domestic currency's rate of depreciation, since domestic nominal interest rates are normally fixed administratively.