Tuesday, September 23, 2008

it's a tax code problem as well

these wall street "titans" sometimes have been referred to as "masters of the universe." uh huh. steep leverage, busted stocks; a death wish? no, unfortunately it may be rational behavior. sky-high debt, on and off wall street, is actually a matter of public policy. it's built into the tax code.
leverage obviously bites back sometimes; we've been underscoring that point lately. but, institutionally, bankruptcy is a risk worth taking. one quarter of the people on the forbes 400 list (i got the issue today) owe their fortunes to finance and investment, three times the fraction when they started the list in 1982 (if my math is correct).

it begins with government, which is itself addicted to debt. politicians get themselves elected by handing out entitlements now and leaving the costs to be picked up by later generations. but, like the street-corner addict, the government has become a pusher, too, tempting citizens and businesses to get in hock by way of the deduction for interest. the tax code makes savers into saps and debtors into financial geniuses.
many think the mortgage interest deduction is/was a subsidy for homeownership? it's not. the tax reward for owning a home, and it's a big one, consists of not having to declare the home's rental value as income. i learned that from my dad a long time ago. the interest deduction is something else entirely -- it's an incentive keyed not to the size of the house but to the size of the debt; it's a reward for putting only 3% down for example.

if homeowners are motivated to use 30-to-1 leverage, so are fnm, fre and leh, obviously. returns on equity capital get taxed twice (at the corporate and shareholder levels), on debt capital only once. that's because corporations get a deduction for interest they pay. so corporations (other than many tech firms, who use equity) load up on debt.
what's wrong with all this is when banks or homeowners go bust, there's a clamor for a bailout. taxpaying citizens--the frugal ones, that is--and we know who we are--end up getting stuck with the bills.
possibly, in an ideal world, there would be no tax deductions for interest, and interest and dividend income would be tax-exempt. next best thing: less double taxation of corporate profits. the reduced 15% dividend tax rate should be made permanent. i mean, how stupid is it to raise the cost of equity capital in a struggling economy?

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