What can Iceland teach us about a wealth tax?

The country instituted an emergency tax for three years to sort out its problems. Should we?

Iceland’s remarkable recovery can serve as a lesson to the UK.

Having recently paid back its IMF loan quicker than was predicted, Iceland's unorthodox reaction to the crisis has been hailed by economists, policy-makers and the IMF itself. In addition to letting its financial system fail, the country introduced capital controls (which have been met with some skepticism as they arguably prevent foreign direct investment and therefore stunt growth) and leveraged its fiscal policy to pay off debt whilst sustaining consumption. It is this last point the UK should pay heed to, particularly as Clegg declares his support for a wealth tax.

The general theme of Iceland’s 2010 tax reform (pdf) is one of increasing tax revenue whilst offsetting the burden for lower income individuals. For instance, while fuel taxes and VAT were increased, the revenue was partially re-channeled towards public transportation and bottom-quartile households compensated for higher food, heating, and transport costs. Furthermore, in an effort to raise income without affecting consumption, the government implemented an emergency wealth tax rate for the period of 2010-2013. As of January 2011, one year after introduction, the tax rate is 1.5 per cent of net capital for single individuals with more than ISK 75,000,000 (£390,000) or 100,000,000 (£519,000) for married couples. By taxing the top 2.2 per cent of the population, the Icelandic government was able to raise 0.3 per cent of GDP in revenue every year.

However, an IMF report on the country's reform argues that the wealth tax should be abandoned as capital controls ease. Because the tax is recurring, the only thing that is stopping the wealthy from offshoring capital is the simple fact that they’re not allowed to. Therefore, IMF economists argue that the revenue from the wealth tax should be replaced by a less mobile base (i.e. real estate and high income). This does not, however, discredit the Icelandic wealth tax as a possibility in the UK; it just means that, as suggested by German scholars, it should be a one-off levy. (For an in-depth assessment of Clegg’s wealth tax go here)

Meanwhile, the biggest lesson the UK can learn from Iceland is that its recovery was at least partially fuelled by the government's struggle against depressed consumption.

Bloomberg's Omar Valdimarsson writes:

Iceland’s growth “is driven by private consumption, investment has picked up strongly and even though, when you look at net exports, those have a negative contribution to growth, it is mainly because imports have been strong, reflecting strong consumption and an increase in income and the healthy expectations of households,” Zakharova said. “Still, exports have been increasing very strongly. Last year was a banner year for tourism. These are all really positive things.”

A handful of Icelandic banknotes are withdrawn from an ATM. Photograph: Getty Images
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Let's turn RBS into a bank for the public interest

A tarnished symbol of global finance could be remade as a network of local banks. 

The Royal Bank of Scotland has now been losing money for nine consecutive years. Today’s announcement of a further £7bn yearly loss at the publicly-owned bank is just the latest evidence that RBS is essentially unsellable. The difference this time is that the Government seems finally to have accepted that fact.

Up until now, the government had been reluctant to intervene in the running of the business, instead insisting that it will be sold back to the private sector when the time is right. But these losses come just a week after the government announced that it is abandoning plans to sell Williams & Glynn – an RBS subsidiary which has over 300 branches and £22bn of customer deposits.

After a series of expensive delays and a lack of buyer interest, the government now plans to retain Williams & Glynn within the RBS group and instead attempt to boost competition in the business lending market by granting smaller "challenger banks" access to RBS’s branch infrastructure. It also plans to provide funding to encourage small businesses to switch their accounts away from RBS.

As a major public asset, RBS should be used to help achieve wider objectives. Improving how the banking sector serves small businesses should be the top priority, and it is good to see the government start to move in this direction. But to make the most of RBS, they should be going much further.

The public stake in RBS gives us a unique opportunity to create new banking institutions that will genuinely put the interests of the UK’s small businesses first. The New Economics Foundation has proposed turning RBS into a network of local banks with a public interest mandate to serve their local area, lend to small businesses and provide universal access to banking services. If the government is serious about rebalancing the economy and meeting the needs of those who feel left behind, this is the path they should take with RBS.

Small and medium sized enterprises are the lifeblood of the UK economy, and they depend on banking services to fund investment and provide a safe place to store money. For centuries a healthy relationship between businesses and banks has been a cornerstone of UK prosperity.

However, in recent decades this relationship has broken down. Small businesses have repeatedly fallen victim to exploitative practice by the big banks, including the the mis-selling of loans and instances of deliberate asset stripping. Affected business owners have not only lost their livelihoods due to the stress of their treatment at the hands of these banks, but have also experienced family break-ups and deteriorating physical and mental health. Others have been made homeless or bankrupt.

Meanwhile, many businesses struggle to get access to the finance they need to grow and expand. Small firms have always had trouble accessing finance, but in recent decades this problem has intensified as the UK banking sector has come to be dominated by a handful of large, universal, shareholder-owned banks.

Without a focus on specific geographical areas or social objectives, these banks choose to lend to the most profitable activities, and lending to local businesses tends to be less profitable than other activities such as mortgage lending and lending to other financial institutions.

The result is that since the mid-1980s the share of lending going to non-financial businesses has been falling rapidly. Today, lending to small and medium sized businesses accounts for just 4 per cent of bank lending.

Of the relatively small amount of business lending that does occur in the UK, most is heavily concentrated in London and surrounding areas. The UK’s homogenous and highly concentrated banking sector is therefore hampering economic development, starving communities of investment and making regional imbalances worse.

The government’s plans to encourage business customers to switch away from RBS to another bank will not do much to solve this problem. With the market dominated by a small number of large shareholder-owned banks who all behave in similar ways (and who have been hit by repeated scandals), businesses do not have any real choice.

If the government were to go further and turn RBS into a network of local banks, it would be a vital first step in regenerating disenfranchised communities, rebalancing the UK’s economy and staving off any economic downturn that may be on the horizon. Evidence shows that geographically limited stakeholder banks direct a much greater proportion of their capital towards lending in the real economy. By only investing in their local area, these banks help create and retain wealth regionally rather than making existing geographic imbalances worce.

Big, deep challenges require big, deep solutions. It’s time for the government to make banking work for small businesses once again.

Laurie Macfarlane is an economist at the New Economics Foundation