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United States: US Tax System Blamed For Financial Crisis

Monday, 26 August 2013   (0 Comments)
Posted by: Author: Mike Godfrey
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Author: Mike Godfrey

According to an article for Project Syndicate by Mark Roe, a Harvard Law School professor, the tax preference for debt within the United States corporate tax system played a more major role in the 2008 financial crisis than is generally thought.

Roe points out that the tax system, which favors debt over equity by allowing the deduction of interest payments from taxable income, may have already encouraged the over-accumulation of debt by financial institutions, companies and individuals, before a final substantial loading of short-term debt by banks pushed financial markets over the edge.

However, Roe writes, an argument that this tax preference for debt "played a role in the financial crisis – and that it remains an ongoing risk to financial stability – was quickly rejected." As a result, he adds, "regulators have focused on command-and-control orders to financial firms to increase their equity, and to reduce the riskiness of their investments."

With President Barack Obama proposing corporate tax reform, and Congress also working on its proposals, Roe now proposes a revisiting of the "supposedly weak connection between corporate taxation and the financial crisis."

In presenting another view of the onset of the crisis, he suggests that: "The taxation issue may go deeper. The tax system first encourages financial firms to use more debt than is safe, but there is a parallel effect on non-financial firms and many homeowners. Tax deductions for interest payments encourage them to borrow, too, an issue that has long been understood. … Were their demand for debt lower – and, in the case of corporate debtors, were they to rely more on equity – financial institutions would face less pressure to use so much debt themselves."

He concludes that, with consideration having been given in the past to tax reform that "levels the playing field for equity relative to debt," and "as the Obama administration moves ahead with its new proposals, it should look back at the financial crisis, which provides strong grounds for implementing such a change."

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