Corporate taxation, leverage, and macroeconomic stability

A key challenge for economic policy today is to make the financial system more resilient. The literature finds that high indebtedness (or: leverage), both in the financial and in the real sectors, is a danger to macroeconomic stability and growth. Moreover, the design of the corporate tax system is an important determinant of leverage: in many countries interest paid on debt is tax-deductible while the return on equity is not, such that tax systems incentivize debt-type financing and, hence, leveraging. This article summarizes the debate about the implications of corporate taxation for leverage and economic stability. Proposals for addressing the debt bias of taxation are also presented.