Should Jordanian banks pay Windfall Tax for 2023?

Central Bank of Jordan  CBJ
(File photo: Jordan News)
Central Bank of Jordan  CBJ

Hamza Alakaleek

Hamza Alakaleek has graduate degrees in International Political Economy and International Business Law from Yarmouk University and University de Montreal with focus in Internet of Things, Artificial Intelligence and Data Protection.

The Federal Reserve has been raising interest rates as part of its strategy to combat inflation. Consequently, this has led to increased interest rates on various types of loans, including mortgages, car loans, and credit cards. In response to the US Federal Reserve's actions, the Central Bank of Jordan (CBJ) has also raised interest rates on all monetary policy tools. The CBJ's decision aims to uphold the monetary and financial stability of the Kingdom of Jordan. Additionally, it seeks to enhance the competitiveness of assets denominated in Jordanian Dinars by maintaining an appropriate interest rate structure that aligns with recent global and regional interest rate trends.اضافة اعلان

In 2023, the Italian government introduced a one-time windfall tax of 40 percent on banks. This specific tax targets the substantial profits that banks have generated due to rising interest rates.

The rationale behind this tax
The rationale behind this tax lies in the argument that banks have reaped excessive profits from these rate hikes. This arises from the fact that banks typically pass on only a portion of the interest rate increase to savers while charging borrowers higher rates. As a result, banks have witnessed a boost in profits, while savers have experienced diminished interest earnings. The government's objective in implementing this tax is to provide assistance to individuals grappling with the escalating cost of living. The generated tax revenue will be utilized to implement measures that aid individuals in managing their mortgages and other debts.

A conversation about additional taxes on the profits
Consequently, a discussion has emerged advocating for additional taxes on the profits banks acquire through elevated interest rates during the tax year 2023. This stance hinges on several factors, including Jordan's specific tax laws, the quantum of banks' profits, and the consequences of interest rate hikes on their financial performance. Firstly, banks stand to gain windfall profits from elevated interest rates, as they charge borrowers more without reciprocally raising deposit interest. This dynamic effectively transfers wealth from borrowers to banks.
While raising interest rates can help contain inflation, it can also yield adverse outcomes such as hindering business growth and consumer affordability. For example, banks creating loans essentially introduce new money into the economy, which, when utilized to purchase goods and services, can stoke inflation.
Secondly, it is observed that banks contribute to inflation in various ways. Higher interest rates increase the cost of borrowing for both businesses and consumers, potentially curbing economic activity and exacerbating inflation. Banks can also directly foster inflation by expanding the money supply through loans, generating excess money in circulation. This can heighten demand, leading to price inflation. Moreover, banks can indirectly contribute to inflation by enabling increased business borrowing, which stimulates investment and production, subsequently driving inflation.

It can also yield adverse outcomes
While raising interest rates can help contain inflation, it can also yield adverse outcomes such as hindering business growth and consumer affordability. For example, banks creating loans essentially introduce new money into the economy, which, when utilized to purchase goods and services, can stoke inflation. Additionally, loans to consumers amplify money circulation, promoting increased consumer spending and contributing to inflation. Furthermore, banks' investments in assets like stocks and bonds can inflate their prices, thereby adding to inflationary pressures.

The argument continues by emphasizing that banks are already highly profitable entities. In 2022, the average profit margin of Jordanian banks stood at 17.3 percent, surpassing the global average of 13.9 percent. Noteworthy banks in Jordan with high profit margins included Arab Bank (23.4 percent), Housing Bank for Trade and Finance (20.2 percent), Bank of Jordan (18.1 percent), and Jordan Ahli Bank (17.6 percent). In contrast, the United States saw an average return on equity for banks at 10.6 percent in 2022. This rate notably exceeded returns in other industries. A study by the Institute of Taxation and Economic

Policy disclosed that the top five US banks paid an effective federal income tax rate of merely 6.6 percent in 2020, significantly below the statutory federal corporate tax rate of 21 percent. Additionally, these banks paid an average effective state and local tax rate of just 1.2 percent.

The argument gains further traction by highlighting banks' utilization of tax avoidance through insuring bad debt returns. These loans are reinsured with international insurance firms. When these bad debt conditions align with amounts designated as bad debts in the bank's annual budget, the compensation policy is invoked to secure the agreed insurance coverage. Nonetheless, banks continue pursuing debtors for these amounts despite claiming insurance allowance. The tax accounting exemptions on insured bad debts are exploited, allowing banks to simultaneously claim debts and sue debtors.

However, the windfall tax proposal has faced criticism from certain economists who contend that it could discourage lending and potentially slow down economic growth.

Valid counterarguments
Therefore, valid counterarguments come into play. Firstly, implementing the proposed tax would necessitate amendments to income tax laws, making it possible for banks to modify lending practices to evade taxes. Secondly, the tax could discourage banks from lending, as the anticipation of extra taxes on their profits might dampen their willingness to extend loans to businesses and consumers.

This could hamper economic expansion. Thirdly, it might be deemed unfair to levy additional taxes on banks, as their rate adjustments are primarily reactions to market dynamics. They are operating within legal and ethical bounds, though there has been increasing pressure in recent years to subject banks to higher interest rates in response to their record profits and perceived insufficient contributions to the economy.
However, the windfall tax proposal has faced criticism from certain economists who contend that it could discourage lending and potentially slow down economic growth.
However, it is vital to acknowledge that banks aren't the sole contributors to inflation. Other factors like supply chain disruptions and rising energy costs also play significant roles. Banks, nonetheless, wield considerable influence over inflation and can significantly impact the economy. In the current climate of escalating inflation, banks find themselves navigating a delicate balance. They must elevate interest rates to temper economic activity and mitigate inflation while avoiding rates that could impede business growth and consumer affordability. The intricate interplay between these factors will shape banks' strategies moving forward, with far-reaching consequences for the economy and inflation.

Underscores the inherent risk
Additionally, the discussion underscores the inherent risk within banks' lending activities. These institutions undertake substantial risks when extending loans, potentially incurring significant losses if loans turn bad. This risk factor contributes to the high profit’s banks are able to generate. Moreover, banks' societal value is highlighted, as they are pivotal in providing loans to both businesses and consumers, facilitating transactions, and payments.

The complexity of the issue
Examining the potential consequences of imposing higher taxes on banks further illuminates the complexity of the issue. Banks might offset the tax increase by raising fees and interest rates, impacting borrowers and potentially slowing down the economy. However, the broader economic conditions and borrower riskiness are also significant factors influencing banks' lending decisions. Furthermore, the government could tailor the tax to target specific bank activities rather than a blanket approach to lending.

Ultimately, the impact of higher taxes on banks' lending practices hinges on numerous variables and is challenging to predict definitively. In general, while elevated interest rates can boost banks' profits by allowing them to charge more for loans and financial products, they can also escalate costs by necessitating higher payouts on deposits and funding sources. The net effect of these interest rate increases on Jordanian banks' profitability remains uncertain. The decision to levy additional taxes on banks for profits accrued from increased interest rates is intricate, involving well-founded arguments on both sides. It's a decision that necessitates thorough consideration of all pertinent factors. Ultimately, the choice to raise taxes on Jordanian banks in the 2023 tax year is a political one, requiring the government to weigh potential revenue gains against potential ramifications for the banking sector.

Dr. Hamza Alakaleek is a Corporate lawyer and tax consultant with post-graduate degrees in international political economy, international business law, and law and technology with a focus on internet of things, artificial intelligence and data protection.

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