Interest Equalization Tax

Interest Equalization Tax was a domestic tax measure implemented by U.S. President John F. Kennedy in July 1963. It was meant to make it less profitable for U.S. investors to invest abroad by taxing the purchase of foreign securities. The design of the tax was to reduce the balance-of-payment deficit. Although it was originally intended to be a temporary tax, it lasted until 1974.[1]

Purpose

The purpose of the tax was to decrease the balance of payments deficit in the US. This was achieved conceptually by making investments in foreign securities less appealing. By increasing the price of the security, investors will buy fewer of them, all else equal. With fewer domestic investors purchasing foreign securities, capital outflows will be lower, thereby reducing the balance-of-payments deficit. The equation for the balance of payments is:

\text{BOP} = \text{current account} - \text{capital account} \pm \text{balancing item} \,

The identity for the capital account is:


\begin{align}
 \mbox{Capital account} & = \mbox{Change in foreign ownership of domestic assets} \\
   & - \mbox{Change in domestic ownership of foreign assets} \\
   
\end{align}

So when capital outflows are decreased, the capital account decreases. When the capital account decreases, the balance-of-payments increases.

Dates Effective

The tax was effective on purchases made after July 18, 1963. It was scheduled to expire on January 1, 1966, but was extended multiple times, and eventually abolished on January, 1974.

Amount of the tax

  1. For debt obligations having 3 to 3.5 years remaining until maturity, the tax is 2.75% of purchase price
  2. For debt obligations having 28.5 years remaining until maturity, the tax is 15% of purchase price

Exemptions

Estimated Revenue

The tax was expected to raise $30 million per year.

Effect on the Deficit

As the original intent of the Interest Equalization Tax was the reduce the balance-of-payments deficit, a majority consider the tax successful.

Since many factors influence the balance-of-payments account, the effect of the tax is unclear. However, there was a positive trend in the years after it was enacted.

Effect on Financial Markets

The interest equalization tax "brought American investment activity in foreign markets to a virtual standstill."[4] However, financial markets responded over time with massive evasion of the tax, along with the development of the eurodollar market.

References

  1. Joint Committee on Taxation. "The Interest Equalization Act of 1963". US Congress. Retrieved 27 February 2011.
  2. Joint Committee on Taxation. "The Interest Equalization Act of 1963". US Congress. Retrieved 27 February 2011.
  3. Butterworth, Robert A. (June 1970). "The United States Interest Equalization Tax". Lawyer of the Americas 2 (2): 164–72. JSTOR 40175358.
  4. Markham, Jerry W. A Financial History of the United States. p. 328.
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