Cypriot banks supposedly hold something like 68 billion euros, of which it is bandied about that a third might be due to Russian tax-evaders, many of them maffiosi. Consider what this meant for the deal that was being proposed to the Cypriot parliament over the week-end: the parliamentarians would have had to vote in a 10% direct haircut on the deposits of large bank accounts (those over 100,000 euros), with as the alternative the likely collapse of the Cypriot economy, at least in the short run.
Let us leave aside for a moment the arguments about whether or not it can make sense to directly tax deposits by stealth. Just think about the politics of this deal: the opposition parliamentarians get, in one swoop, to decide on whether or not for their country to ‘steal’ some 2 to 3 billion euros from Russian tax-evaders (assuming here that they have the bigger accounts). From a national point of view, its a no-brainer in the short-run (you tax what you can, preferably foreign assets). But from the point of a party and individual parliamentarians, their votes suddenly became worth 2 to 3 billion to wealthy and possibly maffiosi Russians.
What would a savvy corrupt parliamentarian do? Stall and try to make a deal with the wealthy, of course. A golden opportunity to earn well over a lifetime’s worth of income in one fell swoop. And what would a Russian maffiosi do if he knew he was about to be fleeced for 2 billion by people with a name, a house, and a family? He’d probably threaten and bribe his way out of trouble. What did we thus see last weekend and until Tuesday? Stalling and, wonder of wonders, no deal.
Quite independent of the issue of whether it might make economic sense, it was basically asking nearly the impossible of Cypriot politicians to tell them vote in a few days time on whether or not to grab money from people richer, more powerful, and much more dangerous than themselves.
How should one normally hence do this? Normally, one prints a lot of money overnight. That way you get a quick burst of inflation. Same net result, which is to have basically taxed all deposits proportionately. But the politics are far easier, though there too you will find the incentive to ‘tip off’ the right people. Now, why did the Cypriots not do this? Because its the ECB that prints the money, not them.
A very clean example of how one can tax financial assets by stealth by increasing the money supply, but not by taxing them directly if one needs political negotiation.