Did the Double Tax on Corporate Income Kill the Economy?

By :: December 11th, 2008

Did bad tax policy help cause the economic meltdown? Former assistant Treasury Secretary for Tax Policy Pam Olson thinks so.

Speaking at a Dec. 5 tax reform conference sponsored by TPC and Tax Analysts, 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.

There isn’t any doubt about the disease. By any measure, corporate debt has soared to unprecedented levels in recent years. It was $10 trillion at the end of 2007. The use of credit market instruments increased nearly 10-fold from 2003 to 2007. Overall non-financial business debt/equity ratios topped 60 percent last year. This year, it is anyone’s guess.

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.

Still, as Bill Gale argues, the very high debt loads that many companies carried into the slowdown made them especially vulnerable. Now, stuck with big interest payments, and unable to raise new cash with both debt and equity markets effectively closed to them, these businesses have little choice but to cut costs by slashing their workforce. Just ask Sam Zell, who is putting the Tribune Company into bankruptcy to avoid defaulting on his debt.

No doubt, too much leverage is making today’s recession worse. The question on the table is: How much is the tax code to blame?


  1. Anonymous  ::  11:23 pm on December 11th, 2008:


  2. Anonymous  ::  5:11 pm on February 2nd, 2009:

    It is more likely that the current difficulties are traceable to the lower tax rate, which gave the wealthy more money for speculation in both secondary markets and the toxic derivatives and mortgage securities, as well as the unregulated commodity investment, that led to the collapse.
    There were simply too many saved dollars chasing too little real investment in plant and equipment. This is the feature of all bubbles and booms.
    Taxes help siphon off the excess. The best part of the Obama economic plan, and the one which should be enacted soonest, is the ending of the Bush tax cuts on the rich.
    It wasn't WWII that ended the Great Depression, it was the tax rates that accompanied it.

  3. Anonymous  ::  5:40 am on March 23rd, 2009:

    I agree with you Michael. The wealthy people are given more opportunities to get higher interest rates which makes them spend millions of cash unwisely. They spend too much on expensive clothes, jewelries and branded accessories using fashion ads like those on magazines and periodicals. Granted, it's likely that it has more to do with zealous marketing departments for fashion magazines than actual merit, but some high end periodicals such as the International Herald Tribune runs some fashion ads that seem irresponsible in a recession. For example, Luis Vuitton handbags (small luggage that costs about $1,000) and Rolex and Patek Phillipe watches cost way more than you'll be able to afford with online payday loans. (Casio works just as well, by the way.) It almost seems unfair to allow the existence of fashion magazines when you think about it.

  4. Anonymous  ::  5:14 am on November 19th, 2009:

    Absolutely not. Pam has been working for the IRS too long. Her argument is devoid of how the choice of financing (debt or securities) affects earnings per share, the obligation of managment to shareholders, and capital projects analysis in general.

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