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The alternative of (tax-based) capital controls for Greece

Posted by (Author) on February 11th, 2015 - 15 Comments

At first glance, the potentially catastrophic consequences of Grexit on the rest of the Eurozone provide the Greek government with an important bargaining chip. However, the Greek government should take into consideration that Grexit is not the only possible alternative in case an agreement with the rest of the EZ cannot be reached soon. A more probable outcome is the imposition of capital controls with the discontinuation of ELA. These capital controls would provide ample time for the Greek government to chart its path and for the Greek people to definitely decide their future inside or outside the euro. More likely, capital controls could end up being long-lasting in the case of Greece.

Capital controls would be less costly for Greece than Grexit. Moreover, capital controls would isolate the Greek system and impose a minimal cost to the creditors as compared to the potential negative consequences of Grexit. The latter two points imply that the Greek Government might have less leverage in the negotiations than they appear to think. Unless they were willing to put the Grexit option in a referendum and then prepared to denounce debt upon exit. However, since the latter would have greater cost for Greece than capital controls, it would be unlikely for Greece to go through with this in a rational game setting.

If negotiations fail and Greece has to place capital controls, then they might want to opt for a tax based form as opposed to quantity controls. That is, rather than imposing absolute capital controls on the quantity of capital outflows Greece could place a tax on capital outflows. This would bring in valuable revenue for the Government. It would also have the advantage of a smoother gradual abolition of capital controls as these tax decreased overtime.

This tax would apply to capital outflows unrelated to the trade account, and it could be designed so as to offer incentives (1) to delay outflows and (2) to bring back outflows within a fixed time limit, say a year, once people feel secure enough. For example, a 50 percent tax could be announced along with a commitment that this rate will only go down in the future. The initial level of taxation would be key. This should be high enough in order to avoid huge capital outflows and to make it credible to commit to only lower it over time, perhaps at a pre-arranged (but somewhat flexible) pace. In addition, any funds that flow out but are returned, say, within a year, could get a reimbursement of, say, 50% of this tax. A more flexible design could even allow firms whose business relates to short term movement of funds back and forth, not to be affected. The exact level of taxation, time, and flexibility that is desirable should be decided by the Greek government based on the best available information and with technical help from the ECB and the IMF. Additional complications include its monitoring and the potential for the trade account to be used as a loophole in any case.

The above scenario would offer Greece the time it needs to make up its mind while providing the Greek government with an important source of precious revenue in the meantime. This would not be a first best, but both Greece and the rest of the Eurozone would be better off under this scenario as compared to the Grexit scenario.

Categories → Οικονομία

  1. avatar
    • avatar
      Marios Zachariadis on February 11, 2015 - (permalink)

      Yes, I agree that capital controls will be bitter but still preferable to Grexit for the rest of the EZ and Greece (as I had told Neil who called before writing his article after reading this: )
      In relation to Savvakis opposite point, unilaterally “denouncing the debt upon exit” would cut off Greece from the international economy for a long-while. Recent research (a number of papers available here e.g. #5 and #6) shows that Sovereign Default is much more costly than economists thought up until a few years ago:
      Having said this, there is no precise calculation, just my best informed guess based on the most recent reliable empirical research on Sovereign Defaults by top researchers in the field. Regarding, applying the tax to Cyprus, that was my suggestion as of March 2013 but it’s now too late for Cyprus.

      • avatar
        Savvakis Savvides on February 11, 2015 - (permalink)

        Thanks for the reply. I tried to download and read the two references you point out but could not find them. Email me if you have a copy. Nevertheless, whatever these researchers are arguing, I am sure they never had such acute problems and levels of public and private debt owned by foreigners as we have in Greece and Cyprus. The benefits from a potential write off are surely much greater in cases where the repayment is impossible and a strict austerity program is holding the prospect of recovery beyond reach. This is why Iceland decided to follow this route. I don’t think it was isolated from the rest of the world (not even for a month). Moreover, I am not sure at all what are the significant costs to a defaulting country. In my book, Governments should not be borrowing in the first place (this is just indirect taxation that is wasteful and passed on to future Governments and which finally has to be paid by the tax payer). So, not much is lost in that respect.

  2. avatar
    Kax on February 11, 2015 - (permalink)

    The “allies” are threatening the banks.In order for the Greek government to be able to negotiate it must impose capital controls and proceed with a bail in.If the banks convert enough of their deposits into equities the outflow will be limited.We have an example in Cyprus.This time they must be fair to the depositors and issue shares at very low prices so those who need the money can sell their shares at the Stock Exchange without losing much money.Around 60pcent of the banks belong to the government,the majority of the rest to foreigners.Most probably the deposits largely belong to Greek people and companies.

    Your proposal hits the depositors as opposed to the shareholders.We are told the Greek banks are strong but lets not forget they are strong because they received government funds whch it got from the Troika.So let the shareholders take the loss,not the depositors.

    After the Greeks neutralise the threat to the banks then we have to wait for the market reaction to see who has the best negotiating hand.The argument of the “allies” that they gave money,the Greeks agreed so they have to honour their agreement is correct legally.Morally we all know the money bailed the German and French banks ,not the Greek people.

  3. avatar
    Savvakis Savvides on February 11, 2015 - (permalink)

    Marios, you make a good suggestion regarding the capital outflow tax which in my mind should be considered for Cyprus as well given that the biggest problem we face are the gargantuan remaining deposits which do not allow a return to economic normality. Since the bail-in left most of these in tact, in my mind, such a tax will begin to pave the way towards a permanent solution to the problem.

    One question however, how did you reach the conclusion that “putting the Grexit option in a referendum and denouncing the debt upon exit” is a greater cost for Greece than capital controls? I beg to differ. Capital controls is a temporary cure, debt write off is long term/permanent, thereby creating the conditions for the rebuilding of the economy on sound and solid foundations. See Iceland for example.

  4. avatar
    MM on February 11, 2015 - (permalink)

    Nice suggestion. However, would the EU be prepared to leave the matter ‘in transit’ till Greece makes up its mind what to do, and in the meantime the markets to bleed due the ensuing uncertainty?

    I hope I am wrong, but the Eurogroup will want firm commitments from Greece, and will not allow a long prolongation of the agony.

  5. avatar
    ez on February 11, 2015 - (permalink)

    From where is Greece going to find the ten billion euros that it requires in short term financing?

  6. avatar
    Erol Riza on February 11, 2015 - (permalink)


    I am not sure that a Grexit will be catastrophic as you suggest. In terms of the holders of Greek bonds these are mostly held by the ESM and the ECB so apart from the political reverberations it is not clear to me, given the market complacency we see at the moment, that it will be a catastrophic event.
    There is no doubt that Greece deserves less austerity which is suggested by the 3% primary surplus but it must be under some commitments the Greek government makes during the bridge period and herein lies the compromise. If there is though a fundamental difference on how Greece would introduce reforms and manage its finances going forward it may not find many takers in the Eurozone and the two may agree to disagree again.
    I am thus led to wonder what good would capital controls be if this addresses the symptom and not the fundamental issue whether the Greek government is mindful of its responsibilities after the haircut and restructuring of debt and the fact that other countries have implemented MOUs and have seen the benefits. Could it be that both are better off if Greece was assisted with Grexit?
    I would be grateful to have your views on the issue of whether Greece can convince and gain the trust that it will implement a program consistent with its obligations, even during the bridge period given the populist measures we saw in two weeks.

  7. avatar
    Marios on February 11, 2015 - (permalink)

    What do you mean tax based Capital Controls unrelated to the trade account?
    If by this you mean only tax on outflaws overseas (which do not relate to economic activity ie imports) then this maybe is feasible at a theoretical level, still not applicable at a practical level.
    If you mean tax on all Outflaw transactions (including cash from the ATMs, local transfers, credit card transactions and overseas transfers) then this cannot work at all.

    The problem with any theoretical concept like the one you suggest is to ignore all the practical sideffects that will create which will probably create bigger problems than the ones they are intending to solve.

    You also do not say whether this will be applicable only to existing funds or to new deposits as well. If it applies to new deposits as well, that means that the economy will revert to cash (as in physical cash) transactions only. Nonone will ever deposit any more money in the banking system.
    For example cash from the ATMs being taxed means that also money from salaries will be taxed.

    And if you mean only tax on Overseas Outflows (not related to commercial activity like imports) then such Capital Controls can be easily circumvented over time.
    I have studied extensively the Cyprus Capital Controls. These in the beginning were for cash, domestic transfers and overseas transfers.
    Even from the beginning it was relatively easy to circumvent the overseas transfers capital controls and many did. Examples include exporters (includingh tourism industry) receiving the money overseas or another business co-operating with an exporter to pay him in Cyprus and get the money overseas. Or even the simple strategy of asking a few friends who did not want to get their money overseas to use their Eur5.000 overseas allowance per bank to get money overseas. And note what I just described was completely legal in Cyprus. In Cyprus there was no legal requirement for an exporter to get the money back in Cyprus.
    The reason why not all the money have left Cyprus after 03/13 was because a big amount was frozen at BoC and the situation normalised after a few months and people stopped sending money overseas.

    Now you put a 50% tax on overseas outflows and all the ingenuity of the world will descend on Greece and find ways to get the money out even if you put much stricter laws than those that applied in Cyprus.

    Also note that a fundamental premise of Cyprus Capital Controls regarding foreign transfers is that new Foreign Inflows (of whatever origin including exports) were exempt from any Capital Controls. Without this specific measure the whole banking system would have collapsed.

    The fundamental difference of applying Capital controls (or tax based capital controls) to a Euro Country is that the Euro is an international currency. Previous historical examples of such capital controls where with currencies that were not freely exchnageable internationally. With the Euro ways will be found for the money to get out over a relative short period of time of a few months unless the situation is normalised.

    The number 1 issue of Capital Controls is Cash at the ATMs. As in Cyprus the number 1 measure is to limit the cash withdrawals so that the ATMs do not run out of money. In Greece the problem will be even bigger because it might not be possible to bring in new physical cash to replenish the ATMs (assume that such a measure needs the ok from ECB which will not give it).

    My belief is that , in any case the Introduction of Capital Controls because of no agreement reached with EU will be just an intermediate practical arrangement to arrange for the practicalities of Grexit. It will not be to give Greece time to decide. The decision will be irreversible on economic terms. Unless is reversed immediately after, ie within a couple of weeks Greece or EU give in to the other side’s demands and agreement is reached.

    I believe that Capital Controls like Cyprus (but a lot stricter) will be introduced in the absence of an agreement. Because by definition normalisation will not have incurred (unlike Cyprus which got into a program at the same time) this is only to give time for the practicalities of Grexit. And in any event people will believe that this is only the intermediate step for the Grexit (meaning whatever money are left in the banking system when Grexit occurs will be converted to Euro).
    The incentive to get the money out of the banking system (either Cash or overseas) will be much higher than Cyprus. People will stop paying in Euros liabilities that are in Euros (ie bank loans, taxes etc) that they have the option to defer with the prospect of paying them in the new currency. The situation will be a lot worse than Cyprus post 03/2013. The expectation of imminent Grexit and the economice actions of all economic actors will become self-fulfilling and make the Grexit a lot sooner.

    • avatar
      Marios Zachariadis on February 11, 2015 - (permalink)

      It would resemble the capital controls we had in Cyprus in many ways some of which you mention above, except that instead of restrictions on quantities there would be an equivalent tax that would bring about the same outcome in terms of overall outflows. It would face some of the same problems as the capital controls witnessed in Cyprus, but would have the additional benefit of bringing in revenue for the government. Note that (1) forbidding capital outflows (Cyprus March 2013) is equivalent to the minimum tax that would lead you to decide not to transfer any capital abroad (2) more generally, any quantity restriction is equivalent to a tax that would lead individuals to choose the same outcome (rather than force them via a quantity prohibition) and (3) in general, taxes dominate quantity restrictions in terms of welfare.
      Finally, note that the EZ would have an incentive to finance and sustain this scheme for a period of time (including via allowing ELA) as it would be less costly for the EZ than Grexit.

      • avatar
        Μ on February 12, 2015 - (permalink)

        Mr Zachariades,

        Even though I believe that your suggestion is interesting, I think that it doesn’t satisfy the principle of proportionality and therefore it might be inapplicable. According to the case Law of the EU Court of Justice, any derogation from the Treaty in relation to the freedom of capital movement, could be justified on grounds of public security (the article 65(b) of the Treaty is relevant), only if the principle of proportionality is observed.

        I quote the following:

        “The CJEU has established (see e.g. case C-423/98, Albore, §19) that the requirements of public security cannot justify derogations from the Treaty rules such as the freedom of capital movements unless the principle of proportionality is observed, which means that any derogation must remain within the limits of what is suitable for securing the objective which it pursues and must not go beyond what is necessary in order to attain the pursued objective.”.

        The imposition of restrictions on the quantities of the outflows is necessary to attain the pursued objective, which is the public security. A tax on the outflows though might go beyond what is necessary. It’s my interpretation though.

  8. avatar
    Παναγιώτης Σαββίδης on February 12, 2015 - (permalink)

    Many fail to see the connection between capital controls and a parallel currency. Any attempt to move money out of the country will be dealt with a tax that will bring the value of the Euro to at least parity with the new currency if not at a worst position.

    People will have multiple accounts with different currencies and many options to transact without the need to print money.

    • avatar
      Marios on February 12, 2015 - (permalink)

      Yes, I agree with that statement, Capital Controls are effectively a parellel currency.
      Untill recently Cyprus was working with 3 (not 2) currencies.
      Cyprus Euro Money subject to Capital Controls
      Normal Euro Money – Fresh Money which came from Overseas not subject to Capital Controls
      BoC Frozen Euro Money (released completely on 31/1/2015)

      For BoC Frozen Money there were actually many transactions that took place in the beginning at a discount from Normal Euro Money.

      Now Cyprus is still working with 2 currencies.
      But the High Limit for Transferring Euro Overseas, Eur 20.000 per person per bank per month for any reason + the relatively easy way to get even more out if someone wants + the expectation that all Capital Controls will be removed in the near future means that there is no more any discount to Cyprus Euro money.

  9. avatar
    Anonymous2 on February 12, 2015 - (permalink)

    The Greek government knows full well that option B is to impose capital controls, should the ECB stop providing ELA to the Greek banks, which is a real possibility if no agreement is reached next week. That is why it’s reassuring everyone there will be no Grexit. However, these controls will need to be both draconian and quantitative, they may also include a tax element but on its own a tax may not be enough to achieve the required outcome. Without ELA, ATM withdrawals would be reduced to minuscule amounts e.g 50 euros per account per week. That cannot be achieved with a tax alone. Any form of capital controls would be bad for confidence and would be tantamount to embarking on the slippery road towards Grexit. That’s why a compromise needs to be reached sooner than later. Someone will need to concede first in this game of chicken and it will no doubt be the weaker player.

  10. avatar
    Erol Riza on February 13, 2015 - (permalink)


    There are no interim solutions but political decisions on the fundamental issues as the Dutch Minister of Finance and head of the now defunct Eurogroup stated.

    “There has to be a political agreement on the way forward” before serious negotiations can start, Eurogroup President Jeroen Dijsselbloem says.
    We need to read between the lines what this means for the reform program, the debt and how the weekend negotiations will develop.
    I believe the Minister of Finance of Cyprus has been quite right to send the message to Cypriot politicians who have harboured ideas of following the Greek attempt to break from structural reform which is what Greece is clearly going to have to continue if it is to receive future funding from the ESM or ECB.

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