Did the Tax Code Cause the Financial Crisis?
Posted at 10:30 a.m. on Aug. 22
Mark Roe makes the case that tax code’s preferential treatment of debt over equity was a major cause of the financial crisis and ensuing recession.
“To be sure, the tax preference for debt has been embedded in the economy for a long time, with no financial crises for most of that period… Financial institutions fell off the cliff in 2008, it is argued, because they got too close to the edge. Destabilized by too much short-term debt and too much exposure to risky, overvalued, low-quality mortgage-backed securities, they tripped and fell over it.”
“But consider another way of viewing the crisis and our financial institutions: the financial system was never all that far from the cliff’s edge, even before 2008, because the tax system encouraged financial firms to overload themselves with debt… The added risks pushed the financial system past the tipping point, but the baseline problem was that it always contained too much risky debt… The policy consensus has properly focused first on the new risks that were added. But focusing on those added risks should be only the first step; doing so should not lead us to ignore the baseline risks that the tax system creates.”