Financial Products and Services Fact Sheet

The Progressive Consumption Tax (PCT) is meant to tax spending, not savings or earnings. To achieve this, the Progressive Consumption Tax Act (PCTA) contains special rules to ensure that savings and investment income, such as interest income, are not taxed.
Financial products and services are subject to special rules because breaking out savings and investment earnings from the provision of services is often difficult in practice.
Take the example of a bank loan. Banks incur labor and other costs in originating and servicing loans and working out bad debt. Some of these costs can be recovered through separately stated charges – for instance, a loan servicing fee. However, banks operating under a consumption tax would have the incentive to recover these costs as a component of the interest rate charged on the loan. Because the cost would be “hidden” in the interest rate—and thus the investment income earned on the loan—the bank would not have to charge tax on its loan servicing and administration services.
Another example is a savings account. As with servicing loans, banks incur labor and other costs in administering a customer’s account. Banks operating under a consumption tax could recover these costs simply by allowing the customer’s account to earn a lower interest rate.
The same could be said for “free” services that the bank provides. For instance, the cost of issuing “free” paper checks to accountholders can be recovered by lowering the interest rate that the account earns. Because the cost of the “free” paper checks is not charged to the customer, but is instead hidden in the lower interest rate, banks would not have to charge tax on the provision of the paper checks to the customer.
Below is further information on how the PCTA treats financial products and services, along with specific open issues.

The Progressive Consumption Tax (PCT) is meant to tax spending, not savings or earnings. To achieve this, the Progressive Consumption Tax Act (PCTA) contains special rules to ensure that savings and investment income, such as interest income, are not taxed.

Financial products and services are subject to special rules because breaking out savings and investment earnings from the provision of services is often difficult in practice.

Take the example of a bank loan. Banks incur labor and other costs in originating and servicing loans and working out bad debt. Some of these costs can be recovered through separately stated charges – for instance, a loan servicing fee. However, banks operating under a consumption tax would have the incentive to recover these costs as a component of the interest rate charged on the loan. Because the cost would be “hidden” in the interest rate—and thus the investment income earned on the loan—the bank would not have to charge tax on its loan servicing and administration services.

Another example is a savings account. As with servicing loans, banks incur labor and other costs in administering a customer’s account. Banks operating under a consumption tax could recover these costs simply by allowing the customer’s account to earn a lower interest rate.

The same could be said for “free” services that the bank provides. For instance, the cost of issuing “free” paper checks to accountholders can be recovered by lowering the interest rate that the account earns. Because the cost of the “free” paper checks is not charged to the customer, but is instead hidden in the lower interest rate, banks would not have to charge tax on the provision of the paper checks to the customer.

Below is further information on how the PCTA treats financial products and services, along with specific open issues.

General Treatment of Financial Products and Services

The PCTA defines a very narrow category of “financial supplies” that are exempt from PCT. These categories are based on experiences with the implementation of modern goods and services taxes, such as those in Australia and New Zealand. All other financial-related products and services that do not fall into these categories are subject to the PCT. For instance, if a bank offers an account holder paper checks, the bank must charge PCT on the cost of those checks to the account holder.

2016 Update: Financial Products and Services Refinements

The latest version of the PCTA contains several refinements related to financial products and services.  These changes are based on the experiences of practitioners from other countries with modern goods and services taxes, as well as suggestions from U.S. stakeholders.

Partial credits for certain inputs related to financial supplies

In particular, the updated PCTA contains a regime similar to the “reduced input tax credit” regime in Australia’s GST system.  This approach is intended to counteract a problem called “self-supply bias.”

As noted above, the PCTA defines a very narrow category of “financial supplies” that are exempt from PCT.  Because no input tax credits are available for purchases of goods and services related to making exempt financial supplies, businesses making financial supplies have more incentive to move those goods and services “in house.”  In other words, instead of contracting with a separate company to purchase, say, online account maintenance, financial institutions would have an incentive to use their employees to provide this service.  Among other things, the self-supply bias creates three distortions:

  • Enforceability.  Self-supply makes it harder to distinguish between non-taxable savings and investment income and implicit fees embedded in exempt financial supplies. 
  • Small business concerns.  Small businesses that don’t have the scale to insource, or businesses that rely heavily on independent brokers rather than in house employees already, are at a disadvantage compared to those who do. 

  • Reliance on non-resident providers.  Because they will not be able to claim input tax credits in the U.S., financial institutions may be tempted to acquire services performed outside of the U.S., not subject to the PCT.  This will decrease the PCT amount that they pay and make in-country service providers less competitive.

The updated PCTA opts to fix the self-supply bias using the solution devised by the Australian government in the early 2000s.  Specifically, the Act provides reduced input tax credits for certain inputs (i.e., purchases of goods and services) related to the provision of financial supplies.  By allowing financial services companies and banks to claim partial input tax credits for these inputs, there is less incentive to move the inputs in house; small businesses that must outsource these inputs are not disadvantaged; and there is less of an incentive to use offshore inputs.

Ancillary financial supplies

Sometimes, businesses provide some small financial services to their customers, but providing financial services is not their main business.  For example, a repair shop might extend lines of credit to certain customers, though its main business is providing repair services.  

To lower the administrative burden for these businesses, which would otherwise have to separately account for their exempt financial supplies (and the purchases relating to those supplies), businesses who do not reach a certain threshold with respect to financial supplies and financial supply purchases are entitled under this draft of the PCTA to a full credit for all of their purchases.  This threshold would, however, require businesses that provide ancillary financial supplies to do some separate tracking to ensure that they do not exceed the threshold.

What still needs to be done?

The application of consumption taxes to the financial services sector is difficult. Further feedback from stakeholders is needed to ensure that complicated financial transactions are taxed appropriately.

Specific issues raised by financial products and services are detailed in our Additional Input document.  While other countries have experiences with these issues that are very helpful to draw from, we anticipate that the U.S. financial services industry will have unique challenges that will need to be considered and addressed.

How do I submit a comment on the PCTA’s application to financial products and services?

Comments on all aspects of the PCTA, including the financial products and services section, are welcome. If you have a suggestion on the Progressive Consumption Tax Act, or more questions, please email PCT@cardin.senate.gov.  

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