IMF Report: Taxing Times – October 2013

The report is called “Taxing Times”. In this report the IMF recommends the USA does the following: Increase taxes; New capital controls; Sieze retirement funds and Bring the national debt down to pre-banking crisis 2007 levels. You can download the report here:http://www.imf.org/external/pubs/ft/f…

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Box 3. Learning from the Crisis? Taxation and Financial stability

The global economic and financial crisis brought substantial rethinking of the tax treatment of the financial sector, following public outrage at the extensive public support it received and a growing perception that some features of the tax system may have played a role in encouraging the high levels of leverage at the root of the crisis.

By allowing interest payments, but not the return on equity, as a deduction against the corporate income tax, most tax systems encourage the use of debt finance. This “debt bias” has long been known to be empirically important for nonfinancial companies, but recent work shows the effect is just as strong for banks (de Mooij and Keen, 2012; Hemmelgarn and Teich- mann, 2013). The effect is small for the largest banks, most critical to financial stability, but this does not mean it is unimportant: these banks also tend to be very highly leveraged, and since the probability of crisis is a strongly convex function of overall bank leverage, even small tax-induced changes in leverage can have a large effect on the probability of crisis. Starting from the high levels of bank leverage just before the crisis, results of de Mooij, Keen, and Orihara (2013) imply that eliminating the debt bias would have reduced the probability of crisis by 20 percent or more in several countries (Figure 3.1).

A dozen or so advanced economies have introduced “bank levies” that go some way toward addressing these concerns (OECD, 2013a). The core of the base is typically uninsured bank borrowing, but there are wide differences in the rate, the definition of the base, and whether the resulting revenue is earmarked for resolution purposes. There is emerging evidence that while raising relatively little revenue, such levies have indeed reduced bank leverage (Devereux, Johannesen, and Vella, 2013). Key issues are whether to strengthen these taxes and whether to address problems of international coordination arising from differing structures and potential double taxation. A broader approach, in principle eliminating the debt bias entirely, would be to introduce an “allowance for corporate equity” (ACE) form of corporate tax, which provides a deduction for the notional cost of equity finance, along with that for interest—as Italy, for instance, has recently done.1

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