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Harvard Law Professor: US Tax Policies Helped Spark 2008 Financial Crisis

By    |   Friday, 23 August 2013 07:55 AM

The U.S. tax system itself may have caused the 2008 financial meltdown because it encouraged both financial firms and individuals to overload themselves with debt, according to Mark Roe, a Harvard Law School professor.

Roe dismisses the widespread mantra that reckless behavior by big banks was the primary reason for the disaster.

Instead, he explained, corporate tax policy allows financial firms to deduct interest payments to creditors from taxable income, with the result that equity is not taxed as favorably as debt is.

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"Most countries have similar tax preferences for debt over equity, thereby encouraging financial and other corporations to use more debt, as financial analysts have long known," he wrote in an article for Project Syndicate.

With the possibility that a U.S. corporate tax overhaul may be in the wings, Roe said the timing is right to examine the role taxes played in the meltdown.

Roe said that "while reliance on debt made financial institutions riskier, creditors knew that, in a crisis, the government would probably bail out the largest, if not all of them. Government was less likely to bail out equity."

The problems with the U.S. tax system run deep in American society, according to Roe.

"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."

In fact, tax deductions for interest payments encourage non-financial companies and homeowners to borrow more, also — with the effect that those parties feed the demand for even more debt by financial firms, Roe wrote.

Calls for trimming the top U.S. corporate tax rate from the current 35 percent have come from the Obama administration, Congressional leaders of both parties, and business groups. The U.S. top rate is higher than that of other developed nations. And that discourages investment in the United States and encourages income shifting to avoid tax, proponents of reform maintain.

But, as is typical in Washington, the proposals to reduce corporate taxes do not include specific provisions to replace the lost revenue.

The Joint Committee on Taxation recently estimated that reducing the rate to 25 percent — and eliminating the corporate alternative minimum tax — would cut government revenue by $1.3 trillion over the next decade, Forbes reported.

Congressional leaders are expected to unveil a proposed rewrite of the tax code after the August recess, according to Reuters. Congress has mostly kept a public lid on its discussions about the topic until now.

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The U.S. tax system itself may have caused the 2008 financial meltdown because it encouraged both financial firms and individuals to overload themselves with debt, according to Mark Roe, a Harvard Law School professor.
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Friday, 23 August 2013 07:55 AM
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