Public Information Notice: IMF Executive Board Holds Board Seminar on Debt Bias and Other Distortions: Crisis-Related Issues in Tax Policy

June 16, 2009

Public Information Notices (PINs) form part of the IMF's efforts to promote transparency of the IMF's views and analysis of economic developments and policies. With the consent of the country (or countries) concerned, PINs are issued after Executive Board discussions of Article IV consultations with member countries, of its surveillance of developments at the regional level, of post-program monitoring, and of ex post assessments of member countries with longer-term program engagements. PINs are also issued after Executive Board discussions of general policy matters, unless otherwise decided by the Executive Board in a particular case.

Public Information Notice (PIN) No. 09/76
June 16, 2009

On June 1, 2009, the Executive Board of the International Monetary Fund (IMF) held a seminar on “Debt Bias and Other Distortions: Crisis-Related Issues in Tax Policy.”


Having considered the implications of the crisis for the broad state of the public finances some weeks ago,1 the Executive Board considered in this seminar whether there are any longer term lessons for tax policy design. They discussed a staff paper that explores channels by which tax distortions may have worsened the financial vulnerabilities exposed by the crisis, and considers policy responses that may be appropriate, with the timing of their implementation depending on the nature of the response. The staff analysis stresses that tax distortions did not cause the crisis, but emphasizes the risk of excessive leverage that is implied at corporate level by the preferential tax treatment of borrowing, and at household level, potentially, by tax relief for mortgage interest payments. It also addresses the role of tax considerations in encouraging the use of complex and opaque financial instruments and arrangements (including through low-tax jurisdictions), and in the structuring of executive compensation packages. The paper argues that while many of these tax distortions have existed for many years, they raise macroeconomic concerns significant enough to warrant greater attention than they have commonly received.

Discussion by Executive Directors

Executive Directors welcomed this opportunity to review long-standing issues related to debt bias and other tax distortions, and to draw preliminary lessons for the broad direction of structural tax reform. They agreed with the staff’s finding that these tax distortions did not trigger the financial crisis, but may have contributed to excessive leverage and other financial market problems. However, Directors also noted the greater importance of other factors, such as lax lending standards, regulatory/supervisory weaknesses, and poor financial risk management. While stressing that tax issues are inherently difficult, Directors found the staff paper useful in identifying areas where wider discussion could contribute to enhancing the efficiency of national tax systems, strengthening members’ fiscal positions over the long term, and fostering appropriate cooperation.

Directors considered that neutrality in tax treatment across assets and over time is an important benchmark for policy design and evaluation. At the same time, they emphasized that other considerations also come into play when formulating tax policies, including the desirable size and role of the state, social and distributional objectives, stage of economic and financial development, and regulatory and administrative constraints. Efficiency considerations would therefore need to be weighed against prevailing national agendas, taking due account of country-specific circumstances: there should be no one-size-fits-all approach. Against this background, Directors considered that the Fund has a role to play in providing policy advice and technical assistance to its member countries, drawing on the expertise of other specialized institutions where possible. A few Directors thought it important to extend the analysis raised in the paper to guide the Fund’s tax policy advice and technical assistance for emerging market and developing economies.

Most Directors noted that allowing deduction for interest payments, but not the cost of equity, at the corporate level might affect the choice between debt and equity finance, encouraging greater borrowing. To level the playing field between debt and equity finance, some countries have limited interest deductibility or instituted an Allowance for Corporate Equity or variants. While cautioning that changing long-standing tax practices involves significant transitional and other problems, and that countries’ differing circumstances require close attention in formulating advice, most Directors felt that debt bias issues warrant attention in countries’ tax reform programs. They also underscored the need for strengthened regulation of the financial and corporate sectors where broader concerns about macro-financial stability exist.

Directors considered that special tax treatments could potentially increase household leverage and house prices, but agreed with staff that tax policies neither explained the observed house price boom nor triggered its collapse. Any changes should be carefully sequenced and planned, taking account of social objectives and present fragility in housing markets. For the short term, reducing transaction taxes would often be a more appropriate way to support housing markets than by introducing more tax breaks. Over the longer run, consideration could be given to phasing out preferential tax treatment as conditions permit, and introducing better targeted programs to pursue wider social objectives.

Directors observed that tax considerations have been a factor, albeit not a dominant one, behind the development of complex financial instruments and structures. This was an area where further study is warranted, on the role, if any, of tax-motivations in developing complex instruments and transactions, as taxes may affect both risk allocation and risk-taking through the use of these instruments. They recognized, however, that fully eliminating these tax-motivated transactions is likely impracticable, as it would require very fundamental tax reform.

Directors noted the distinctions presented in the staff paper between tax evasion and avoidance as well as tax havens and low-tax jurisdictions, and the role of the OECD on tax information exchange. In this context, some Directors noted the positive role played by tax competition in disciplining government spending. Others were concerned at the potential impact on revenues and some members’ fiscal positions. A number of Directors supported a Fund role in policy discussions in this sensitive and highly complex area, complementing other multilateral and regional fora. A number of other Directors stressed that the Fund’s role should remain limited to avoid duplication of effort and recognize the expertise of other bodies such as the OECD in particular.

Directors drew attention to the tax treatment of alternative forms of executive remuneration, noting that in some cases such treatment may have contributed to greater risk-taking and short-termism. Some Directors cautioned that misaligned corporate governance and incentive structures, which lead to principal agent problems, are also highly germane. While rules are complex and vary substantially across countries, it is important that taxation not encourage the use of inappropriate compensation arrangements.

Most Directors noted that the effects of tax policies on asset prices can be substantial but also complex and hard to predict. Ad hoc measures are unlikely to be the best way to deal with unwelcome asset price movements, as they could add to tax complexity and entrench inappropriate treatment. Sound macroeconomic policy and targeted regulation are more effective in addressing the root causes of the problems.

1 See PIN No. 09/31 on the Executive Board seminar, held on February 20, 2009, on “The State of Public Finances: Outlook and Medium-Term Policies After the 2008 Crisis.”


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