Behind the Cyprus Tax: Russian Deposits and a Suspicious EU

A protestor shouts slogans outside of parliament during a meeting in capital Nicosia, Cyprus, on March 18 Photograph by Petros Karadjias/AP Photo

The tiny island nation of Cyprus let Russians park tens of billions of euros in its banks, with no questions asked. Now the island’s finances are in tatters. So why not make the Russians pay for a bailout?

That’s what Germany and other European creditor nations argued as they pushed for a steep tax on Cyprus bank deposits.

As financial markets opened this morning, the “why not” became painfully clear. Stocks worldwide took a nosedive, the euro currency plunged, and borrowing costs spiked for Italy, Spain, and other weak economies across the euro zone. “Traders and investors are aghast,” Michael McCarthy, chief market strategist at CMC Markets in Sydney, told Bloomberg Television as the trading day began.

It’s no surprise investors are spooked. The Cyprus deposit tax takes aim at the one asset people thought was still safe: their bank accounts. Bondholders, taxpayers, and others have made big sacrifices over the past three years to help rescue wobbly banks and bring Europe’s debt crisis under control. But until now, no one had suggested that bank depositors take a haircut.

To no avail, European leaders are arguing that this is a one-off solution to a unique problem. If the debt hawks can do this in Cyprus, investors fret, what might they demand in other crisis-hit European countries? The plan is “a worrying precedent with potentially systemic consequences,” Joachim Fels, chief economist at Morgan Stanley in London, told clients in a research note.

The plan, announced on March 16, would impose a minimum 6.75 percent tax on even the smallest accounts. The Cypriot parliament is scheduled to vote on the measure tomorrow and could decide to shift more of the burden onto big account holders.

While the idea of zapping Russian oligarchs may have political appeal, the Cyprus tax would hit plenty of other people. It’s true that Russian banks and companies have $31 billion in Cypriot banks, according to estimates by Moody’s Investor Services. And there’s evidence that Russian money is sometimes laundered there. Millions of dollars stolen from the Russian treasury in a tax fraud uncovered by attorney Sergei Magnitsky were later traced to Cyprus bank accounts.

But Russian deposits still account for less than half the total $88 billion in the island’s banks. Deposits by Cypriots make up most of the rest.

What’s more, not all the Russian money in Cyprus is dirty. Legitimate Russian businesses have complained for years about tax laws that perversely encourage them to register their businesses offshore. Otherwise, they have to pay taxes on their sales to foreign customers and then apply to Russian tax authorities for refunds that are difficult or impossible to obtain. Such companies are attracted to Cyprus because of its low corporate tax rate.

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