The government hearts debt
The ongoing economic crisis has been, in every way, a crisis of debt. The banks were brought down by mortgage debt. Wall Street -- and, quite nearly, the economy -- was brought down by leverage. But as James Surowiecki writes, "Debt didn’t get dangerously out of scale because the system was broken. It got out of scale, in part, because the system worked."
The government doesn’t make people go into debt, of course. It just nudges them in that direction. Individuals are able to write off all their mortgage interest, up to a million dollars, and companies can write off all the interest on their debt, but not things like dividend payments. This gives the system what economists call a “debt bias.” It encourages people to make smaller down payments and to borrow more money than they otherwise would, and to tie up more of their wealth in housing than in other investments.
Likewise, the system skews the decisions that companies make about how to fund themselves. Companies can raise money by reinvesting profits, raising equity (selling shares), or borrowing. But only when they borrow do they get the benefit of a “tax shield.” Jason Furman, of the National Economic Council, has estimated that tax breaks make corporate debt as much as forty-two per cent cheaper than corporate equity. So it’s not surprising that many companies prefer to pile on the leverage.
These policies have been around a long time, but as Surowiecki says, we shouldn't mistake longevity for permanence. "In the U.S., people used to be able to write off the interest they paid on credit cards. That tax break was abolished in 1986, and, the same year, the mortgage-interest deduction, which used to be unlimited, was capped. Great Britain, meanwhile, abolished its mortgage tax break in 2000. Similarly, there are a number of countries, including Brazil and Belgium, that don’t give corporate debt a tax advantage over equity, while, just last year, both Germany and Denmark cut back sharply on their business-interest tax breaks, limiting how much interest companies can write off."
The economic crisis has led to a lot of huge policy responses, but not much in the way of policy changes. This, however, is one change we may come to regret not making.
Graph credit: James Quinn.
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