Bloomberg News

Fed’s Kocherlakota Calls on Congress to Change Tax System

June 27, 2011

(Updates markets in 11th paragraph.)

June 27 (Bloomberg) -- Federal Reserve Bank of Minneapolis President Narayana Kocherlakota called on Congress to change the nation’s tax system in a way that discourages banks and households from accumulating debt.

Consumer and bank leverage reduce stability in the financial industry and increase the potential for a crisis like the one that struck the U.S. from 2007 to 2009, Kocherlakota said today in a speech in Big Sky, Montana.

Regulators are trying to avert a repeat of the turmoil that began with the collapse of the U.S. subprime-lending market and that has led to $2.08 trillion of writedowns and credit losses at financial firms. The regulatory overhaul signed into law last year by President Barack Obama makes the Fed supervisor for institutions deemed systemically important.

“The U.S. tax system encourages leverage by providing incentives for households to take on more mortgage debt and financial institutions to finance through debt,” Kocherlakota said in remarks to the Colorado, Montana & Wyoming Bankers Associations. It does so “even though both are potentially destabilizing.”

The regional bank president called for a reduction in the fraction of mortgage interest that households can deduct from their taxable incomes and of interest payments that corporations are allowed to deduct.

Tax Incentives

“I would assess the costs of providing tax incentives for leverage to be higher today than such an assessment in, say, 2006,” Kocherlakota said. “Congress should modify the U.S. tax system to reduce the incentives for destabilizing activities by banks and households.”

Global central bank governors agreed this weekend on extra capital rules for banks whose size or systemic importance means their failure could cause another financial crisis. Regulators agreed that as many as 30 of the world’s largest lenders should face surcharges that range from 1 percentage point to as much as 2.5 percentage points of core capital to prevent them from causing another financial crisis.

Financial industry executives, such as JPMorgan Chase & Co. Chairman and Chief Executive Officer Jamie Dimon, say raising capital requirements will hurt consumers and banks as the U.S. economy struggles with an unemployment rate of 9.1 percent.

More Capital

Higher capital requirements for banks and non-banks regarded as systemically important is a “valuable” idea, Kocherlakota said today in response to audience questions after his speech.

The 47-year-old bank president has led the Minneapolis Fed since October 2009 and is former chairman of the economics department at the University of Minnesota. He earned his bachelor’s degree in mathematics from Princeton University and his doctorate from the University of Chicago.

U.S. stocks rose, rebounding from three days of losses, with the Standard & Poor’s 500 Index climbing 0.9 percent to 1,280.10 at the 4 p.m. close of trading in New York.

The regional chief voted with the rest of the Federal Open Market Committee last week to keep the central bank’s balance sheet at a record level to spur the weakening economy. He did not comment on the decision or the future path of policy in his prepared remarks.

The central bank is set to complete $600 billion of bond purchases this month, and Kocherlakota is among the Fed officials who want to lift the benchmark U.S. interest rate this year to combat rising inflation.

The policy maker, in response to audience questions, said he is keeping a “close eye” on core inflation, which excludes food and energy.

--With assistance from Craig Torres in Washington. Editors: Carlos Torres, Christopher Wellisz

To contact the reporters on this story: Vivien Lou Chen in San Francisco at vchen1@bloomberg.net

To contact the editor responsible for this story: Christopher Wellisz in Washington at cwellisz@bloomberg.net


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