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After years on the naughty step, Britain’s banks were delighted — and surprised — by Rachel Reeves’s pre-election pledge to “unashamedly champion” the sector. Some now fear the Labour chancellor will instead hit them with big tax rises. This would be unwise.
The nervousness is understandable, if unsubstantiated. It would not be the first time that an avowedly growth-focused government targeted banks making record profits on the back of higher interest rates. In 1981 Conservative chancellor Geoffrey Howe announced a one-off 2.5 per cent tax on deposits, euphemistically described as a “special fiscal contribution”.
Should Reeves decide to raise the sector’s taxes, she could change the rate of the bank levy on banks’ balance sheets or the surcharge on their profits — both introduced since 2010. Another de facto tax increase would be to stop paying so much interest to banks on the reserves at the central bank created during quantitative easing.
The last of these looks unlikely. Reeves has warned of dangers in making changes. Bolstering the bank levy would also be an odd move. It is a particularly distortive, growth-damaging tax, which is in effect borne by customers.
Increasing the surcharge is the most plausible option, especially as it was cut from 8 per cent to 3 per cent in 2023 when the corporation tax rate rose from 19 to 25 per cent. Shore Capital’s Gary Greenwood says that every percentage point rise would increase the tax rate of Lloyds Banking Group and NatWest by a similar amount, with a smaller impact on Barclays and HSBC.
Nonetheless it would be an own goal (and not just because the government holds about 18 per cent of NatWest). Risk-averse banks can put the brakes on growth — as tacitly acknowledged by Thursday’s announcement that the Bank of England has watered down plans for stricter capital rules.
Taxation can affect banks’ ability to lend, and not just because they can respond by repricing loans. Even though the big UK banks’ profitability has soared, it is barely above the level that investors require to compensate for the riskiness of the returns. Returns on tangible equity of 14 per cent are around the same level as their cost of equity, according to the BoE. Nor are investors showing widespread confidence about the future. Lloyds’ price to tangible book ratio is 1.2 times for the year ended June, but Barclays’ is just 0.6 times.
Increasing the surcharge could be presented as the reversal of a “Tory tax break”. That may seem more politically palatable than other revenue raisers. But the risks of unintended economic consequences are real.
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