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Windfall taxes can have unintended consequences for the economy. While they may provide short-term revenue for the government, they also have a negative impact on investor confidence and future business prospects. This is especially true when the taxes are large and imposed without careful consideration.
A recent example of this is a surprise windfall tax on Italian banks. The draft proposal suggests taking 40% of the additional profits generated by banks due to high interest rates. It appears to be a last-minute decision aimed at appeasing voters who believe the government has not done enough to support lower-income individuals.
The complexity of the tax is evident from the government’s panicked revisions to its parameters. The tax is based on each bank’s net interest income (NII) in 2021, before policy rates increased. Banks are required to pay 40% of what remains after deducting 110% of their 2021 NII from their 2023 NII. The only exception is if the government would generate more revenue by applying the 40% tax to the difference between their 2022 NII and 105% of their 2021 NII.
This tax mainly targets the 2023 net income, which is projected to be a substantial €32bn for the entire sector, a nearly 70% increase from 2021. If we make a rough estimate, the government stands to raise around €4.5bn from this tax, which is approximately 3% of the sector’s market value before investors lowered it by 8%.
Banks may have ways to mitigate the impact of this tax. For example, they could reduce their NII in the second half of the year by offering higher interest rates to depositors. This would result in lower short-term profits but potentially higher market share. However, such strategies could attract regulatory scrutiny.
Global investors should be concerned not only about the details of this tax reform but also about the manner in which it was announced. The unexpected announcement was made without the presence of the finance minister, and officials had to revise their figures in an early press release, suggesting a lack of proper planning or analysis of the tax’s consequences.
Governments that implement impulsive tax policies can expect to face higher borrowing costs due to increased risk. Shareholders who support the commercial banking sector may question whether their investments are safe from future tax raids.
European bank stocks are undervalued because they are often influenced by political decisions rather than purely market forces.
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