Financial Instability, Tax Policy, and the Tax Expenditure Concept

Southern Methodist University Law Review, Vol. 63, 2011

85 Pages Posted: 8 Oct 2009 Last revised: 15 Dec 2010

Date Written: July 12, 2010


As a public policy goal, moderation of financial instability has gained some prominence in the face of the current credit contraction. Not surprisingly perhaps, the role of tax policy in exacerbating instances of financial instability has begun to receive some attention in the tax-policy literature. Consistent with the general thrust of that literature, this paper explores, in a very preliminary way, how some selected tax-base rule choices line up with an explicit goal of ensuring that the tax system supports regulatory and monetary policies intended to moderate financial instability. The paper frames the inquiry in terms of Hyman Minsky's "financial instability hypothesis" as an explanation of the sources of financial instability. Minsky's work suggests how excessive leverage and risk taking arise and can be seen as defensible targets informing the choice of certain tax base rules, many of which are characterized in the tax-policy literature as efficiency-reducing concessions to revenue concerns. In this respect, the paper draws on tax- expenditure analysis to reconceptualize the possible design of some of these familiar income base rules whose justification is altered somewhat when framed against Minsky's explanation of the sources of financial instability.

More particularly, the paper reviews the incomplete manner in which dividend imputation systems commonly address a tax bias in favor of corporate debt, and how this incompleteness can be justified as a means to promote margins of safety. The paper also reviews the case for and design of loss limitations as applied to financial instruments, as well as restrictions on the deduction of interest expense under the personal income tax as a form of loss limitation. No claim is made to definitively resolve any of these particular base design issues; nor is there a complete canvassing all of the possible issues whose resolution is potentially affected by a focus on financial instability. The purpose of the paper is the much more modest one of suggesting how standard analyses of interest deductibility and the treatment of losses might be reframed with moderation of financial instability as a public policy goal.

Keywords: tax policy, tax expenditures, financial instability, Minsky's financial instability hypothesis, dividend imputation, loss limitations

JEL Classification: E44, E62, H20, H25

Suggested Citation

Edgar, Timothy, Financial Instability, Tax Policy, and the Tax Expenditure Concept (July 12, 2010). Southern Methodist University Law Review, Vol. 63, 2011, Available at SSRN:

Timothy Edgar (Contact Author)

Osgoode Hall Law School ( email )

4700 Keele Street
Toronto, Ontario M3J 1P3

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