The Hoover/Mellon Tax on Checks
It’s heartening to see that virtually everyone who has blogged on the proposed tax on bank accounts in Cyprus has pointed out that this is a set-up for a run on Cyprus banks. I have little to add to that discussion.
What I do have to add, though, is that we’ve seen something like this in U.S. economic history. William D. Lastrapes and George Selgin laid out the details in “The Check Tax: Fiscal Folly and the Great Monetary Contraction,” Journal of Economic History, Vol. 57, No. 4, (Dec., 1997), pp. 859-878. In June 1932, the Revenue Act that Herbert Hoover signed imposed a 2-cent tax on each check. Treasury Secretary Andrew Mellon, one of my erstwhile heroes, pushed for it. Two cents per check is trivial today, but remember how much inflation we’ve had since then. To see how important the tax was, you need to know the size of the average check. Lastrapes and Selgin write:
The Treasury’s own position had been based on its $175 estimate of the mean value of a bank check. A two-cent tax was, of course, unlikely to cause any significant switch to currency for such large transactions. But the Treasury’s figure came from data that included some very large financial transactions. The figure therefore hid the fact that the vast majority of checks, including checks for family expenditures, wage payments, and purchases by agricultural cooperatives, were written for much smaller amounts. For instance, according to the National Cooperative Milk Producers’ Federation, as of 1932 dairy farmers had been receiving approximately 150 million checks annually, with a mean value per check of only $2.15. The proposed tax applied to such checks would therefore have been approximately equivalent to a one-percent tax on dairy products at a time when dairy industry profits were exceedingly slim or nonexistent. Similar circumstances prevailed, though on a smaller scale, in the poultry and egg industries. The [Ways and Means] committee was convinced that a check tax might sponsor a large scale switch to currency-based payments in these industries, at the expense of banks serving them.
Critics of the check tax pointed out the worrisome implication for banks the money supply:
The ensuing reduction of credit would in turn do further damage to the economy as a whole. In the end the committee concurred with a New Jersey banker’s testimony that “if there ever was a time when money should be kept in the banks as distinguished from pockets and money tills, it is now.
And, sure enough, here was the effect:
The check tax therefore accounts for about 26 percent of the actual increase [in the currency/deposit ratio]. As for M1, the check tax accounts for 35 percent of its overall decline (from $25 billion to $19 billion) between October 1930 and March 1933.
In short, the tax on checks contributed to the severity of the Great Depression.