Felix Salmon

The importance of Volcker

By Felix Salmon
October 21, 2009

There’s a curious coincidence of newspaper stories today: just as the NYT’s Louis Uchitelle writes a long piece about Paul Volcker being marginalized, the WSJ runs a story about how he could end up being responsible for what would arguably be the single most important piece of economic policy implemented by the Obama administration.

Here’s how Uchitelle ends his piece:

He travels infrequently to Washington, he says, and when he does, the visits are too short to bother with the office. The advisory board has been asked to study, amid other issues, the tax law on corporate profits earned overseas, hardly a headline concern.

So Mr. Volcker scoffs at the reports that he is losing clout. “I did not have influence to start with,” he said.

Well yes, the tax law on overseas corporate profits is one of the issues that Volcker is looking at. But he’s also, says the WSJ, looking at something much bigger and much more far-reaching:

White House advisers are examining whether to curb the corporate tax code’s bias toward raising money from tax-deductible debt issues rather than from stock sales…

Tax experts for decades have bemoaned the tax code’s bias toward debt over equity: Interest on most corporate debt is tax deductible, while dividend payments are not.

“The disparity between debt and equity financing encourages corporations to finance themselves more heavily through borrowing. This leverage in turn increases the financial fragility of the economy, an effect we are seeing quite dramatically today,” Jason Furman, now deputy director of Mr. Obama’s National Economic Council, told a congressional panel last year.

This is something I’ve been pushing for a while, and it’s a really good idea. As the WSJ article shows, the US, with its 39.1% corporate tax rate, manages to raise just 3.2% of GDP through corporate taxes. Meanwhile, Australia, with a 30% corporate tax rate, raises 6.6% of GDP from corporate taxes. If Volcker starts taxing debt as well as equity, that would do wonders for the US fisc, and would reduce the systemic danger that debt poses to the economy. What’s not to love?

9 comments so far | RSS Comments RSS

Are you assuming that it’s the deductibility of debt that would end? Because right now we have double-taxation on equity (which causes corporations to seek ever higher stock valuations, rather than pay dividends), and taxing debt won’t fix that.

We should end the double-taxation on equity, not double-tax debt too.

Posted by Brock | Report as abusive

In furtherance of your capital market governance blog, I argue against governance policies that conflate “risk” and “uncertainty.” The inability to move away from the risk-uncertainty conflation affects not only capital market governance but the environment, homeland security, education, and healthcare. The gravamen of this problem stems from our policymakers being almost exclusively deterministically trained—law, accounting, and economics. They therefore have difficulty identifying, analyzing, and solving issues that are increasingly becoming more indeterminate.

What we need now is capital market governance of randomness—a blueprint for fundamental change to the legacy, one-size-fits-all deterministic governance regime. I have created such a plan, describing how to do the right things for governance effectiveness and how to do things right for governance efficiency.

The legacy governance system for the US capital market is in disrepair. To achieve real regulatory reform, policymakers have to move beyond form to substantive issues. Unless experimentations to the legacy, one-size-fits-all deterministic regime take place, our capital market will be caught in a recursive loop of errors of commission (boom-bust bubble inefficiencies) and errors of omission (externality market inefficiencies). Such inefficiencies will eventually render our source of economic wealth ineffective.

If this happens, we’re all screwed.

Stephen A. Boyko


Author of “We’re All Screwed: How Toxic Regulation Will Crush the Free Market System”
http://www.w-apublishing.com (http://www.w-apublishing.com/Shop/BookD etail.aspx?ID=D6575146-0B97-40A1-BFF7-1C D340424361)

Book Review: Brenda Jubin, Ph.D Thursday, October 8, 2009
http://readingthemarkets.blogspot.com/se arch?updated-max=2009-10-15T06%3A23%3A00 -04%3A00&max-results=7
Boyko, We’re All Screwed!


The WSJ has been pushing this point since I started reading it in 1974, so I’m not holding my breath.

Posted by JimB | Report as abusive

Brock should replace Larry Summers right now!


Not to put too fine a point on it, this double taxation stuff from the earlier commentor is overblown. The average corporation pays a percentage taxation rate roughly akin to the Social Security taxes paid by the ordinary worker.

I am in fact in favor of no taxes on dividends, since the highly leveraged perpetual growth model favored by most corporations leads executives to do stupid, short-term things. It also leads to the illusion that the only “good” corporation is one that’s growing rapidly.

However, for this to really make sense, corporations would have to be subject to some sort of reasonable flat tax, from which there were no deductibles. Since lobbying Congress for special treatment is beloved by executives and politicians both, I am not holding my breath.

Posted by Tim Connor | Report as abusive

So, since interest paid and dividends paid by corporations are taxable income to someone else, can you compare the tax rates for the interest income and dividend income? Who earns this income? Is it both individuals and other corporations? What are the tax brackets? If corporations switch to paying dividends (to support sale of equity) over interest payments from debt, what will be the total affect on tax revenue?

Posted by Jasper | Report as abusive


There are several problems with prohibiting companies from deducting interest payments from taxable income, both theoretical and practical. To list a few, I think that you’ve conveniently overlooked:

(1) This proposal destroys the economics of being a financial intermediary that lends money and in turn pays interest on borrowed funds (whether those funds are deposits or bonds), i.e., a bank. Go through the math – the traditional business of a bank is to earn a spread based on the interest earned on loans less the interest paid on borrowings (whether deposits or wholesale funding). This proposal suddenly prohibits deducting the latter expense, which means that a bank has to increase the interest rates that it charges to maintain profitability. The underlying problem is that the same income is being taxed 3 times – once as income for the company that borrows from the bank (with no deduction for interest expense), once as income for the bank (again no deduction for interest expense), and a 3rd time as interest income for the person who is a depositor/bondholder of the bank. This treatment also creates a huge incentive for the ultimate borrower – a company – to fund directly in the bond market and limit the situation to double taxation rather than triple taxation. This proposal is equivalent to a big hike in interest rates because it makes credit dramatically more expensive, and the biggest losers would be companies that are too small to access the bond market directly.

(2) If this proposal were phased in immediately, particularly in the current earnings environment, there would clearly be companies that immediately become unable to service their debt. You might claim not to care, but it is reasonable that companies have made cash flow projections based on the tax deductibility of interest expense. To suddenly change such an important provision of the tax code is dramatically unfair. Think of commercial real estate as an example. Have there been some speculative excesses – of course. That said, suppose that an owner of an office building or retail center has done everything in a “correct” or “prudent” manner. The owner has tenants with long-term leases and, based on that certainty, funded a project with 70% or 80% debt. The economics of the project suddenly don’t work solely because a change in the tax code means that interest cannot be deducted.

(3) The complexity created by this proposal could also be a dramatic problem. I would imagine that companies and lenders would find alternate arrangements to reclassify a loan and “interest” as something else. For example, a company might sell its inventory of raw materials to a lender (thus getting cash) and agree to buy back the raw materials over time at a mark-up, turning non-deductible interest into a tax-deductible expense for cost of sales. Though I am far from an expert on Islamic finance, I would expect techniques from this sector to be used across the U.S. economy, since my view is that the goal of much of Islamic finance is to refashion “debt” and “interest” as an economically equivalent relationship with a different name. Attempting to regulate these types of transactions
would be extremely complex.

Felix, I find much of you write to be very interesting, but this idea is not well thought-out. A better proposal – allow corporations to deduct dividend payments and then also tax such payments as ordinary income for the recipients. At that point, we’re treating debt and equity the same, without putting the economy through a wrenching transformation to do it.

Posted by Dave | Report as abusive


you really need to think through your assertion that eliminating the tax deductibility of interest “would do wonders for the US fisc(ally)”.

What you are talking about is an increase in after tax interest rates of nearly 50%. As an example, a loan at 7% interest has an after tax cost of 4.5% (assuming a 35% marginal rate). Eliminating the deductibility increases the after tax cost from 4.5% to 7%, or up 55%.

Do we really need to increase the cost of capital to business by over 50%? Would that do wonders for the US? Quite the opposite.

Posted by marketkarma | Report as abusive

Re \”This proposal destroys the economics of being a financial intermediary that lends money and in turn pays interest on borrowed funds (whether those funds are deposits or bonds), i.e., a bank.\”

Surely it would make sense to distinguish between interest paid in the ordinary course of trade (eg by a bank to depositors)and interest paid on long term debt. I suggest the former should continue be tax deductible.


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