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Working Paper Summaries (WP/92/1 - WP/92/47)
Article

“Reserve Requirements on Bank Deposits as Implicit Taxes: A Case Study of Italy”

Author(s):
International Monetary Fund
Published Date:
August 1992
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Italy’s system of relatively high reserve requirements on bank deposits is a legacy of a long period of weak public finances. In light of the Government’s automatic access to a current account facility with the central bank, the monetary authorities have in the past had to rely on coercive means of monetary control. During the 1980s, they made substantial progress in moving toward a more market-oriented system of monetary control, but the pressures from the monetary financing of the budget deficit did not abate, and the domestic banking system remained burdened by a rising average reserve requirement. The need to alleviate that burden has recently been heightened by the liberalization of international capital flows and by the move toward a single European market.

This paper analyzes the quasi-fiscal effects of reserve requirements, with a view to assessing their importance in the process of Italy’s fiscal consolidation. Compulsory reserves constitute an implicit tax on the banking system insofar as they provide the public sector with an indirect source of financing at below-market rates. To assess the relative contribution of the reserve requirement tax to the overall revenue effort, the paper develops an integrated accounting framework to measure implicit and explicit taxes on the banking system.

The evolution of the associated receipts during the 1980s highlights the shortcomings of implicit taxes. The yield and incidence of the reserve requirement tax are influenced by difficult-to-predict nonpolicy factors, and a lack of transparency hampers coordination with explicit tax policy. These considerations reinforce the case for lowering Italy’s taxation through reserve requirements toward the EC average, provided that this effort is coordinated with a reform of the Treasury’s current account facility. In light of the already small budgetary contribution of the reserve requirement tax, and with existing explicit taxes remaining in place, a halving of reserve requirements would cost the budget no more than 2/10 of 1 percentage point of GDP.

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