Tax Treatment of Compound Interest Bank Loans
Banks charge borrowers interest twice: once as a capital gain and again as a cost of providing the loan. It is called compound interest and does not reflect the reality of the transaction. Banks lend other people’s money, and today, banks lend new money provided by the government. Banks should not get capital gains as they provide a service to the government to distribute new money as loans. The government provides the money.
All interest payments are rent of money plus the cost of risk and providing the service. Both of these are expenses to the borrower and income to the lender. Money can appreciate in value through deflation or depreciate in value through inflation, but money being loaned cannot change its value or have a capital gain.
The idea of banks obtaining a capital gain started in the Middle Ages when banks lent existing money and received a share of the profits generated by the loan. Once banks stopped lending deposits and started lending new government money, the accounting rules should have changed to reflect the new situation. The first and possibly only change should be for the government to tax bank interest like any other service. Interest is a cost to the borrower and is a tax deduction; interest is income to the bank and is taxable.
The two interest payments are costs for a business and should be deductible as a tax deduction. For the bank, they are income and should be taxed. The ATO can and should make this change immediately as it will increase tax receipts until banks decide to eliminate compound interest loans.
Doing so will make lending existing money competitive with bank loans and increase tax collections. The Reserve Bank will then have an extra weapon to fight inflation, as it can, in consultation with the government, decide to restrict banks from lending new government money to investments that increase assets in the community rather than the current system, which uses new money to speculate on future asset prices.
It will probably double the banks' tax liabilities. However, banks will rapidly move to remove compound interest and move to simple interest, which will only charge interest once. This will dramatically increase the nation's productivity and investment in new production and assets. It will stop asset price inflation and, in particular, make housing affordable. Assets will slowly drop in price, and the market economy will still operate normally.
The only change the government needs to make is to ask the ATO to treat ALL bank interest receipts as income.