Systemic Risk, Coordination Failures, and Preparedness Externalities: Applications to Tax and Accounting Policy
17 Pages Posted: 22 Aug 2009 Last revised: 2 Sep 2009
Date Written: August 17, 2009
Sometimes resources are badly employed because of coordination failures. Actions by decisionmakers that affect the likelihood of such failures cause ‘systemic risk.’ We consider here the externality in the choice of ex ante risk management policies by individuals and firms: they are concerned with private risk, not with their contribution to systemic risk. One consequence is that individuals and firms become overleveraged from a social viewpoint. The US tax system taxes equity more heavily than debt, and therefore exacerbates the bias toward overleveraging. A possible solution is to reduce or eliminate taxation of corporate income and capital gains. Preparedness externalities can also cause firms to become too transparent, and thereby subject to financial runs. We consider the implications for debates over fair value accounting.
Keywords: regulation, taxation, systemic risk, risk management, preparedness externalities
JEL Classification: G18, H21, H23, M41
Suggested Citation: Suggested Citation