Why Treasury told the Government it could, but shouldn't, grab a slice of big bank profits via a levy or tax top-up

The Government could've targeted the big four banks with a one-off retrospective levy, or a temporary top-up of the corporate tax rate, if it wished to take a slice of profits deemed to be windfall or supernormal during the peak COVID-19 period, officials advised Finance Minister Grant Robertson.

The advice, following a request from Robertson, came during February and March this year in the lead up to the Budget. Treasury's advice, however, was not to go ahead, and to instead have the Commerce Commission undertake a market study into competition in the banking sector. This is the direction the Government has gone in.

In terms of a levy, options suggested were to impose it at either 1.4%, 2.8% or 4.2% on the net profit of ANZ, ASB, BNZ and Westpac for the relevant years. This, Treasury said, would raise between $230 million and $700 million.

In terms of a top-up of the corporate tax rate applied to the net profit of any banks considered to have experienced a windfall gain, Treasury said a bank with annual net profit of $1 billion would have a normal income tax obligation of $280 million. A top-up windfall rate of 5% would generate an additional $50 million tax obligation for the bank. Treasury said it was seeking legal advice on whether there are any legal risks with applying a levy or tax top-up retrospectivity.

A range of overseas examples are cited in the Treasury papers, including supernormal profit levies in Australia. There banks with over A$100 billion in liabilities are charged a levy of 0.06% per annum on each cent of liability, in a move designed to recover supernormal profits arising from implied guarantee against failure that large banks benefit from in Australia.

Treasury officials also looked at levies on banks in Britain and Germany, and noted Canada's recently introduced “Canada Recovery Dividend”, targeted at windfall profits that's accompanied with a permanent increase to banks' income tax rate to 18% from 15%.

Also cited as examples are levies on what were deemed to be excess profits made by energy producers in the Netherlands and Czech Republic. The Dutch example is a special levy of 33% is imposed in the year ended 2023 on net profit that's more than 20% above the average level of net profit in the 2018 to 2021 years. In the Czech Republic  a special levy of 60% is imposed on the difference between net profits made by energy producers in the year ended 2023, and net profits averaged across the prior five years.

"Of note is that both examples were introduced in response to European energy producers experiencing relatively clearer windfall profits due to the war in Ukraine and subsequent supply disruptions. While the cause and severity of windfall profits in the New Zealand banking sector are not directly comparable, officials consider the core design could be replicable," Treasury said.

'No clear evidence of windfall profits'

Banks’ profits increased in dollar terms in 2021 and 2022 when they were likely supported by favourable economic conditions stemming from the government fiscal and Reserve Bank monetary response to the COVID-19 crisis, Treasury said, but it sees no clear evidence of windfall profits.

"Windfall profits are a form of temporary excess profit that arise from an extraordinary external event, rather than an enduring structural issue, that the firm is not responsible for. I.E. the firm did not anticipate the event, and the firm’s actions did not contribute to the windfall profit. There is no standard definition of windfall profits, but it often carries connotations of being unearned or undeserved," Treasury said.

"In practice distinguishing between windfall and non-windfall profits is difficult because it involves subjective judgements about the degree to which a firm anticipated the event, and whether profits were appropriate compensation for risk."

Ultimately Treasury officials said they didn't recommend a windfall tax in the banking sector citing risks to confidence in the certainty and predictability of the tax system and the effectiveness of monetary and fiscal policy responses to any future economic crises.

"Due to the risk of unintended consequences from introducing a tax on windfall profits, we do not believe there is sufficient justification to recommend a windfall tax. A windfall tax may undermine confidence in the certainty and predictability of the tax system, with potential flow on impacts on investment decisions and long-term economic growth and wellbeing."

"The incidence of a windfall tax is subject to elevated uncertainty, and there is a risk that the costs are borne by depositors and borrowers rather than shareholders. Moreover, applying a windfall tax on profits arising from the growth in bank lending risks undermining the effectiveness of monetary and fiscal policy responses at influencing credit conditions and growth in future crises," Treasury said.

If Robertson and Revenue Minister David Parker wanted to investigate ongoing "supernormal profits" in the banking sector, Treasury recommended they discuss initiating a Commerce Commission-led market study into the banking sector with Minister of Commerce and Consumer Affairs Duncan Webb.

"A Commerce Commission-led market study would have the resources, expertise and information acquisition powers to identify the cause of, and solutions to, any weak competition and elevated profitability in the banking sector. Similar studies in other countries, e.g. Australia, have yielded useful information in recent years," Treasury said.

"Following the findings of that report, expected to take 18 months from when it is initiated, we can investigate tax measures that better target the factors of ongoing supernormal profits."

Officials said if the Government's objective is to tax the big banks' perceived supernormal profits on an ongoing basis, a permanent levy would achieve that more effectively, by preventing income shifting between periods as there would be no periods that the levy would not apply to.

A $1 billion threshold

Targeting the 2021 and 2022 years "appears appropriate as prima facie there would be a higher nominal amount of those profits in those years," Treasury said.

"If you wanted the proposal to target the banks most likely to be making supernormal profits, we suggest a straightforward way might be a $1 billion threshold in both the 2021 and 2022 years. If any banks are earning supernormal profits, we have higher confidence that the banks above the threshold are earning supernormal profits than those below the threshold."

In terms of a temporary retrospective levy on the net profit in 2021 and 2022 years, applied to banks with a net profit of more than $1 billion, this would cover ANZ, ASB, BNZ and Westpac. ANZ's profit over those two years weighed in at $1.919 billion and $2.299 billion with increases of 44% and 20%. ASB's was $1.321 billion, up 38%, and $1.471 billion, up 11%. BNZ's was $1.322 billion, up 74%, and $1.4 billion, up 7%. Westpac's was $931 million, up 69%, and $1.047 billion, up 12%.

As well as the assistance from favourable fiscal and monetary policy, Treasury cites banks reversing provisions for loan impairment losses, elevated inflation, loan volume growth, and widening net interest margins as factors behind the profit surge. It notes, however, that the big four banks have made higher returns over an extended period compared to the rest of the banking industry, with this relative strength persisting in recent years.

"The proposed levy will raise substantial revenue in a way that could support your wider distributional objectives, including but not limited to the costs of Cyclone Gabrielle," said Treasury.

"While the incidence a one off retrospective levy is most likely to fall on [bank] shareholders, there is a risk that at least a proportion of a levy could be passed on to consumers over time whether in the form of lower lending, higher interest rates, or other charges. The extent or timing of that pass-through is unclear, and depends on the trust that banks have that the levy is genuinely one-off, or may be repeated in future years."

"As businesses, banks operating in New Zealand, regardless of where their ultimate parent is based, are subject to the standard corporate tax rate of 28%. In the 2021 income year, the four largest New Zealand banks reported a tax expense of $2.2 billion which would be equivalent to 10.7% of all income tax paid by New Zealand businesses [of] $20.4 billion," Treasury said.

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