The Role of Tax Policy in the Global Economic Crisis

• Author: Glenn Gottselig
• Position: IMF Survey online

IMF Survey online spoke to Michael Keen and Victoria Perry of the IMF's Fiscal Affairs Department about the study's main findings and what role tax policy had in the global economic crisis.

IMF Survey online: Did tax policy play a role in bringing on the global economic crisis?

Keen: The bottom line of our current research is that, while taxation policies did not cause the crisis, they probably contributed to key vulnerabilities that became evident during the financial crisis. In particular, we see tax fingerprints on high leverage, on complexity, on the lack of transparency of financial arrangements, and on risk taking. In our paper, we study these issues and then try to figure out what that implies for tax design going ahead.

IMF Survey online: Did taxation policy play a role in the collapse of the housing market?

Perry: As far as we can see from evidence of others and from looking at these things ourselves, tax generally did not underlie the housing price bubbles. But it is really quite clear that the tax system has in some cases had a large effect on the overall level of household indebtedness, and also on the level of debt relative to home values. So if, for example, somebody with a $200,000 house would have a $100,000 mortgage in the absence of tax, the econometric evidence is that the same borrower would, with the tax system as it now stands in the United States, have a fairly significantly higher mortgage for that same house. This reflects the incentive, in the United States and in many other countries, for borrowers to reduce their income taxes through a deduction of mortgage interest. We don't draw from this the conclusion that we should instantly remove all these housing tax privileges. That's clearly not something one would want to do until the housing market has come back to some kind of normality and health. But on the other hand, we certainly would be cautious in adding new privileges of this kind, which may lead to future problems. It could be useful now, in fact, to reduce housing transaction taxes, taxes that are paid when housing changes hands. These taxes are distortionary, in the direction of reducing the liquidity of the housing market.

IMF Survey online: What stands out as your most important findings?

Keen: One that we think is quite important is the incentive in almost all countries to use debt finance rather than equity finance at the corporate level. That's because companies can deduct their interest payments...