Paul L. Caron

Monday, December 15, 2008

Did Double Tax on Corporate Income Contribute to Economic Meltdown?

Following up on the December 5 conference, Memo to the President: Tax Reform’s Challenges and Opportunities:  Howard Gleckman reports that former assistant Treasury Secretary for Tax Policy Pam Olson fingered the double taxation of corporate income as one of the causes of the economic meltdown:

Pam fingered what she called an “anti-equity and pro-leverage” Internal Revenue Code as one culprit in the collapsing credit markets. TPC’s Bill Gale agrees--after a fashion--although other tax experts are unconvinced.

Her argument: Because corporate income is double-taxed, the easiest way for companies to avoid that levy has been to borrow. Since interest is deductible while dividends are taxed at 15 percent, companies had an enormous temptation to take on more debt. ...

The problem with Pam’s theory is that much over-leveraging happened at a time when dividend taxes were relatively low. The worst of the credit bubble occurred after dividends and capital gains rates were slashed in 2001.

That’s not to say the tax code was entirely innocent. Debt does remain tax-favored and no doubt that encouraged some foolish borrowing. But there was much more going on, including the lack of transparency and regulation, the ability of companies to move debt off their balance sheets, low interest rates, the temptations of leveraged investment in an era of booming asset values, and the explicit link between executive comp and stock prices.

It is also worth remembering that the root of today’s recession was the collapse of financial institutions that were grossly overinvested in subprime mortgages and their derivatives. The sort of non-financial, Main Street business that Pam is worried about were more victims than causes. Not entirely innocent, for sure, but victims nonetheless.

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This has to be on of the most specious arguments ever made by idealogues who believe lower taxation is the cure-all, without any foundation for their belief. We did not have a credit/bank meltdown earlier when the tax rate on dividends was much greater, supposedly causing even a higher debt/equity ratio! You are entitled to your opinion, you are not entitled to make up your own facts.

Posted by: Sid F. | Dec 15, 2008 8:12:14 AM