The conclusion, unquantified and tentative though it must be<sup>34</sup> , is that the deadweight loss from the introduction of lending rate ceilings may be significantly higher - for equivalent revenue - than that from reserve requirements or the inflation tax<sup>35</sup> . It is therefore worth noting interest ceilings on non-government lending are very important quantitatively. They accounted for one-third of the total of taxes and quasi-taxes in Kenya, Nigeria and Zambia, and between 15 and 20 per cent for the other two.

# 4.2 Criteria for better financial. sector taxation.

The high variability of the effective rate of financial sector taxation, as illustrated by the data from African co-untries, is largely attributable to the fact that both implicit and explicit financial sector tax rates are not invariant to the price level or the rate of inflation. An ideal tax 34 Our model does not, for example, expliciLly consider the impact of moral hazard and adverse selection on interest rates, a topic which have been widely discussed in recent years following Stiglitz and Weiss (1981). Highler interest rates will generally convert some potentially viable projects into non-viable ones; furthermore borrowers may shift in favor of riskier behavior if interest rates are higher. For both these reasons the average effective rate of return to banks on loans (net of default) does not increase as fast as the contractual rate. Thare may be a value of the contractual rate such that the average effective rate reaches a maximum. No bank will lend at a rate higher than this value. This implies that the observed schedule between the lending rate and the level of loans is subject to a ceiling. However, note that this ceiling is put in place by private markets; although it may mean that government intervention tu place a ceiling on lending rates is less constraining than it appears to be, it does **tnot** mean that binding interest ceilings have lower marginal efficiency costs.

Another welfare aspect of interest ceilings which has not been considered in the model relates to the tendency of governments to use financial sector taxation at tires of fiscal crisis. Because of the fear that this will happen again, agents are reluctant to expose themselves to financial sector taxation by, for example, having large currency holdings (Ghana is the best example of this withdrawal of the private sector from the financial system as a result not only of high inflation but of the confiscatory nature of the currency reforms). Such precautionary behavior effectively increases the equilibrium interest rate for domestic government borrowing, as the private sector hedges against government recourse to the inflation tax (especially as, because of time inconsistency, the government can not normally precommit itself to a non-inflationary policy). These higher interest rates will result in other taxes being imposed to cover the interest costs, and it is possible that the efficiency costs of these taxes could be greater than the distortions caused by the imposition of an interest ceiling. Accordingly, there might be offsetting welfire gains to the usual losses from an interest rate ceiling imposed in ;.ch circumstances.

35 There is also the point that, to the extent that not all of the borrowers who benefit from the low interest rate were intended beneficiaries of the policy, there is an unintended redistribution involved in having interest rates ceilings.

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