Tax Code Helped Cause Financial Crisis

Budget & Tax News reports on a new study on the effect of tax policy on the financial crisis.

[Author Sam] Eddins also addresses the issue of credit default swaps, one of the more controversial financial instruments, which many economists argue played a role in bringing on the credit crisis. Eddins shows those swaps were influenced by tax policy.

“The purpose of debt securitization products, when viewed through a TAFT lens, is not only diversification and partitioning of risk but also tax minimization,” Eddins writes.

“Credit default swaps are revealed to be a massive tax arbitrage that shifted government tax receipts to Wall Street bonus pools and necessitated the creation of massive quantities of low credit quality debt,” Eddins continues. “The structure of this trade ‘insulated’ Wall Street agents from the credit risk while allowing them to arbitrage the tax savings of their clients as long as counterparties remained solvent.”

The central failure of the credit crisis was not with the market, according to Eddins, and individuals in the markets acted consistently and rationally given the circumstances.

“Rather it stands as an example of the unintended consequence of a tax policy that distorted incentives within the free market system. Regulation cannot control investors from acting in their self interest,” Eddins writes.

The full study is here.  It is complex, but adds one more reason to the list of ways government caused the financial crisis.