The Senate :Rescue Bill"--Including What the Bow and Arrow Issue Is All About

The “bow and arrow” issue deals with an excessive Republican imposed excise tax which is really a sales tax. Under federal law there are a range of excise taxes – most of which are really in the nature of user fees that are then dedicated for various purposes. The gas tax is one example as it goes for roads but there are others.

The most famous excise tax is the Pittman-Robertson Wildlife Restoration Act of 1937 whicjh was signed by FDR and it is one of the many achievements of the New Deal. In 1937, hunters successfully lobbied Congress to pass the Pittman-Robertson Wildlife Restoration Act, which initially placed an 11% tax on all hunting equipment. Over time the tax has been varied. It is now funded by a 1l-percent manufacturers' excise tax on sporting rifles, shotguns, and ammunition and by a 1O% manufacturers' excise tax on handguns. There are various other excise tax rates.

The U.S. Treasury Department collects the taxes and transfers the money to the U.S. Fish and Wildlife Service. The Service for administrative expenses may retain up to 8 percent of the funds and the remainder is apportioned to State wildlife agencies. For each $3 of P-R funds received, the States add at least $l of State money, making the program even stronger. Since its birth in 1937, the P-R program has pumped billions into building a future for the Nation's wildlife and its recreational use. As such, the bow and arrow tax is part of the P-R user fee system with none of this money General Fund tax dollar

Archery entered the picture in 1972, with the passage of the Dingell-Goodling Law specifying an 11 percent excise tax on archery equipment. The proceeds, which now amount to some $25 million per year, are also used for wildlife restoration and hunter safety training. A similar levy on fishing equipment contributes some $100 million a year. All wildlife management and disease control.

For some reason, the Republicans in Congress in 2004 passed a 39% Excise Tax on high end arrows. Why this was done is unclear but it was done. The effect of was to stick it to arrows designed for children. The 2008 arrow provision seeks to reverse an anomaly in that 2004 law that created the 39 cent excise tax on the weapons. Intended for more expensive arrows, the tax also applies to arrows used by Boy Scouts and other youth organizations that cost about 30 cents a piece. As such, this is about user fees paid by sportsmen for sportsmen activities.

As to the Senate Bill’s provisions, as I noted above it has two immediate effects assuming that the House passes it. The two immediate effects will be raising of the FDIC limits [with increased FDIC powers] and the ability of the Federal Reserve to pay interest on overnight reserves. The FDIC limit increase is needed and popular and will stabilize regional banks. When Grandma is pulling money out of B of A because of FDIC limit issues, you know things need to calm down.

The second immediate issue is the Federal Reserve’s ability to pay interest on reserves. In 2006, Congress passed a good banking reform technical corrections bill that enhanced the Federal Reserve’s power to control the banking system. It allowed the Fed to pay interest on funds it puts on reserve.

As I noted before, the reserve requirement (or required reserve ratio) is contained in 12 USC 461 that allows the Federal Reserve to set the minimum reserves each bank must hold to customer deposits and notes. The minimum amount of reserve does not preclude a bank choosing to put more on reserve and Congress in 2006 allowed the Fed to pay interest on reserves as of 10/1/2011. The revised legislation moves up that authority to October 1, 2008.

These reserves are designed to satisfy withdrawal demands, and would normally be in the form of fiat currency stored in a bank vault (vault cash), or with a central bank. Reserve requirements affect the potential of the banking system to create transaction deposits. If the reserve requirement is 10%, for example, a bank that receives a $1,000 deposit may lend out $900 of that deposit.

If the borrower then writes a check to someone who deposits the $900, the bank receiving that deposit can lend out $810. As the process continues, the banking system can expand the change in excess reserves of $9,000 into a maximum of $9,000 of money ($900+810+$729 +...=$9000). In contrast, with a 20% reserve requirement, the banking system would be able to expand the initial $1000 deposit into a maximum of $5400 ($800+$640+$512+...= $4000). Thus, higher reserve requirements should result in reduced money creation and, in turn, in reduced economic activity.
The concept of paying interest on reserves – which I support – dates back to the 1950’s when a number of economists – not just Milton Friedman argued commercial banks should earn interest on the reserves they are statutorily required to hold on deposit at the central bank. That refrain was later picked up by the Federal Reserve.

The rationale is by using open market purchases and sales of securities, the Fed adjusts the quantity of reserves banks hold and thus the interest rate they charge on excess reserves banks lend to each other (the federal funds rate).

But since required reserves earn no interest banks minimized – in the past - the portion of their deposit base subject to requirements and met a growing proportion of the remaining requirement through currency in their vaults rather than cash on deposit with the Fed. The Fed worried that eventually required reserves would be so low it would have trouble implementing monetary policy. If banks earned interest on reserves, these problems would be mitigated.

Another benefit – in a normal situation - is if the Fed oversupplies reserves through open market operations in the morning, banks may end up lending out at any rate they can get in the afternoon, causing the funds rate to plunge well below target. If they earned interest on those reserves, they wouldn’t lend them out at below that rate, preventing such late-day crashes but in this environment it may reduce liquidity.

Paying interest on reserves also allows the Fed another tool to affect the liquidity in various parts of the financial market. Under current procedures, any time the Fed has provided market liquidity by injecting reserves into the banking system the increase in reserves has had to be “sterilized” by selling Treasuries, conducting reverse repurchase or more recently through the route of having the Treasury over fund itself to increase its account at the Fed which then does the deal with example one being AIG. Those means of sterilization threaten to run up against certain balance sheet constraints with the Fed now having a lot less in Treasuries that it hasn’t lent out.

With interest on reserves, the Fed would not have to sterilize injections of reserves into the banking system. Normally, reserve injections need to be sterilized to prevent the fed funds rate from undershooting the Federal Open Market Committee funds rate target – which assumes that banks trust each other – hence the FDIC increase.

With interest on reserves, wherever the Fed sets the rate on its deposit facility would effectively set a floor under the funds rate: anytime the effective funds rate would be below the deposit rate, banks would have an incentive to deposit excess reserves with the Fed. Excess reserves would be “sterilized” by banks depositing them with the Fed.

As I have indicated, I support the interest provision but it assumes that the interest provision is implemented correctly so that banks feel enough security on their reserve situation that they are willing to loan to other banks. If the Fed sets a high interest rate banks on their overnight lending feeling that the reserve interest rate is safer than loaning to other banks, then it could well contract the liquidity of funds as banks do not loan to other banks but keep them on deposit with the Fed.

I sent an email to a friend of mine at the Fed asking what the plan was in terms of its structure and he “would get back to me”. The reason is that the Fed has not discussed how soon they might implement interest on reserves, one obvious reason being that the proposed legislation hasn’t yet become law but also it’s unclear what effect paying interest on reserves would have in the current environment.

Since the mid 1980's Irwin Nowick has worked for the California State Assembly and State Senate on a plethora of policy issues, most notably firearms legislation. He has been described as "The Assembly's resident genius" by a former Speaker of the Assembly and is seen frequently in the Capitol hallways and offices assisting legislators in drafting and amending pending legislation.