To Owe or Be Owned—Depends on How You Tax It


By Ruud de Mooij

In February, President Obama said “Companies are taxed heavily for making investments with equity; yet the tax code actually pays companies to invest using leverage”. And he is right: the corporate tax code in the United States creates a significant bias toward debt finance over equity.

Of course, the U.S. is not unique. In most of Europe, Asia and elsewhere in the world, the tax advantages of debt finance are even bigger than in the U.S.

The crux of the issue is that interest paid on borrowing can be deducted from the corporate tax bill, while returns paid on equity—dividends and capital gains—cannot.

The debt distortion is not new. What is new, however, is that we have come to realize that excessive debt (or leverage) is much more costly than we have always thought. Continue reading

Observations on the Evolution of Economic Policies


Guest post by Michael Spence, New York University,
Professor Emeritus Stanford University, and
co-host of the Conference on Macro and Growth Policies in the Wake of the Crisis

It was a privilege to participate in the IMF conference devoted to rethinking policy frameworks in the wake of the crisis. Highly encouraging was the openness of the discussion, the range of views, the willingness to question orthodoxy, and the posture of humility.

One gets the impression that the crisis has triggered a response that it should trigger, and we have embarked on a path of rethinking conceptual frameworks and policy choices in a way that will contribute to the stability of the system.

That said, the good news is that we recognize that in finance and parts of macroeconomics the models or frameworks are incomplete. That represents a challenge to the academic community. But it also means that, in the short run, participants and regulators will be operating with incomplete models. This will require judgments (which will be uncomfortable in contrast to the earlier sense of certainty). There will be mistakes. And, as Olivier Blanchard said in his excellent summary, we will proceed step-by-step, evaluating the impacts of policy choices and sometimes reversing course. Continue reading

Toto, we’re not in Kansas anymore: Exploring the Contours of the Financial System After the Tornado


By Laura Kodres

Just as a tornado in Kansas transplanted Dorothy and, her dog, Toto, from familiar comforts to the unknown land of Oz, the global crisis has led many to wonder what has become of the global financial system and, more importantly, what will it look like next. Is the wicked witch of the West—excessive risk taking and leverage—really dead?

But now, as the storm subsides, there is time to speculate about what the future financial sector might look like. My IMF colleague, Aditya Narain, and I have done just that in a new Staff Position Note that attempts to discern the contours of this new financial landscape. What is clear is that the new landscape will be influenced by both the private and public sectors—their reactions to the crisis and to each other.

Continue reading

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