Tax Analysts Blog

Taxes and the Financial Meltdown: A Two-Way Street

Posted on Sep 15, 2009

The near-death experience of the world's financial markets and the accompanying recession set in motion a worldwide wave of tax hikes. In the U.K. the Labour government wants top income tax rates to rise from 40 to 50 percent. The Conservative Party is expected to win the upcoming election and raise the rate on the British value-added tax from 20 percent to perhaps 22.5 percent. Spain is considering numerous tax hike proposals to reduce its deficit.

Yes, the economic crisis will reshape the fiscal landscape. The financial meltdown has savaged the revenue capacity of the world's tax systems. But those tax systems are not just innocent victims. They played a supporting role in the crisis by promoting unsound financial practices. In the United States the corporate tax encouraged leverage, and the deduction for mortgage interest fueled housing prices and bloated consumer debt. Low capital gains rates encouraged risk taking. And Clinton-era caps on executive compensation sparked a proliferation of performance-based compensation packages that regulators now say were a major contributing factor to the collapse and near-collapse of many financial giants.

In an interview with the Financial Times U.K. Chancellor of the Exchequer Alistair Darling identifies another way in which tax law contributed to the crisis. He argues that complex corporate structures motivated by tax considerations contributed to inability of regulators and companies themselves to identify risk.

    I do worry when an organisation is structured for tax purposes rather than for the efficiency of its business and the strength of its business, and then perhaps this is something else that, when people sit down and have their boardroom discussions, they need to ask why they’re structured in this way. It was obvious from the problems we’ve had. If you look at RBS, for example, it manifestly did not understand the risk to which it was exposed. It’s quite clear that a casual look around ABN Amro before they’d been bought might have been very instructive, because it was clearly complex, it was clearly opaque and it was clearly a bit of a mess.
The traditional standards for good tax policy are efficiency, fairness, and simplicity. After the smoke clears from the Great Recession of 2007-09 we may want to add something like "not encouraging undue risk, particularly systemic financial risk" to the list.

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