On June 15, the International Monetary Fund (IMF) released a study suggesting national tax policies contributed to, but did not cause, the credit boom and bust that caused the global recession. The IMF noted that countries with income taxes tend to impose heavier tax burdens on equity than debt, thereby tilting the playing field toward greater leverage: “Tax distortions have caused leverage to be substantially higher than it would be under a neutral tax system.”
In the United States, this distortion is especially apparent in the double-taxation of corporate income through the tax on dividends. President Bush proposed to eliminate the tax on dividends, and Congress eventually reduced the tax rate to 15 percent, thereby reducing the destructive distortion to which the IMF report refers. President Obama proposes to raise the tax rate to 20 percent, thus increasing the distortion against equity and in favor of debt. The IMF report highlights yet another aspect in which the President’s economically harmful soak-the-rich tax policies are wrongheaded.
The IMF study notes that another way to reduce the bias in favor of debt is to double-tax debt by eliminating the deduction for interest expense for mortgage borrowers, other individuals, and businesses. The IMF study notes that such a move would likely be politically difficult. More than that, however, it would be economically foolish. The IMF staff needs to recall a simple lesson their mothers taught them years ago: Two wrongs don’t make a right.