Corporate Tax Rates and a Financial Transactions Tax in 2020

By Curtis Dubay

With the 2020 election cycle underway, heated discussions on taxes will be part of the drama. Democratic presidential contenders have floated several tax increases already, including a carbon tax, wealth taxes and higher income tax rates on high-income families. Banks of course need to assess how higher tax rates on individuals would impact their customers and themselves in the case of Subchapter S banks. But it will be proposals for a higher corporate tax rate and a financial transactions tax that would have the greatest negative impacts for the industry.

The 2018 Tax Cuts and Jobs Act lowered the corporate tax rate from 35 percent to 21 percent. This large rate reduction was necessary because the U.S. had fallen far out of step with global corporate income tax rates. For example, the average rate in the OECD was below 25 percent, while the U.S. was still at 35 percent. The rate cut helped all U.S. businesses, including banks, and created incentives to expand operations.

Proposals vary, but a corporate rate increase to 22, 25 or 28 percent is in the range of possibilities under a Democratic administration. Raising the cost to all businesses would very likely cause loan demand to fall, hurting investment and slowing growth in communities.

Several candidates also propose to implement an FTT between 0.1 percent and 0.5 percent. Although the rate makes an FTT seem innocuous, it would have a significant negative effect on investors, the economy and the banking industry.

An FTT would apply to financial transactions like the sale of stock, partnership interests, bonds (potentially including municipal bonds and Treasurys), other forms of indebtedness (potentially including loan sales) and derivatives.

Banks would pay the tax each time they purchase covered securities. This would raise their costs, which could lead to higher interest rates for borrowers, lower rates for depositors and lower earnings for shareholders. If an FTT were applied to loan sales, purchasers could likely reduce the price they are willing to pay for loans.

An FTT would also increase compliance costs. In cases where they are an intermediary for a transaction, whether making purchases on behalf of customers, or facilitating a transaction between parties, banks will have to record the amount of tax and transmit payment to the IRS. The systems to report, monitor, and audit will be expensive and take away resources that could have been used to meet the financial needs of the community.

Most proposed FTTs generally include derivatives. Taxing derivatives would increase costs for banks that use such contracts to hedge risk and make it less economical for them to engage in such transactions. This could increase risk in the banking system if the cost increase significantly increases the cost of issuing derivatives. Farm banks in particular will have to keep a close watch, since farmers are a larger user of derivatives to hedge their risks.

Aside from the impact on banks, an FTT would drive down asset values, which will hurt investors, which now include a majority of Americans that save for retirement through IRAs and 401(k)s. Defined benefit pension plans would also feel a pinch, especially public retirement plans that depend on increasing asset values to meet their obligations to retirees.

Other countries that have tried an FTT—such as the United Kingdom, France, Italy and Sweden—have all experienced trouble with the tax. These problems include reduced share values, reduced trading volumes (which reduces liquidity), financial industry jobs moving to other countries and revenue coming in below what estimators anticipated. The U.S. should expect to experience similar troubles if it adopts one too.

This year will undoubtedly bring more policies that effect the banking industry, both negatively and—hopefully—positively. ABA will be very engaged in any discussion of new taxes—as we were in support of the 2017 tax law—providing detailed analysis of the impact on loan demand and economic growth of any proposed change.

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About Author

Curtis Dubay

Curtis Dubay is a senior economist at ABA.