Among the most prophetic voices prior to the economic crash was UCLA economics professor Harold H. Somers, who warned in 1991 that revisions to the tax code would increase leverage, which could lead to economic disaster:

The result is to tilt the well-worn playing field even more in favor of leveraging, leading to the possibility of another leverage frenzy and debacle at some time in the future.

Professor Sommers explained:

The complete history of the causes of the junk bond debacle of 1989 and 1990 is yet to be written. But the tax incentive must have a prominent place in any comprehensive work. This comment applies to long-term debt where the interest deduction can be a major factor; short-term debt may be dominated by other considerations. What is involved is essentially the shield against income tax that is provided by corporate debt compared with the shields that are provided for equity by the income tax rules …

Former President of the St. Louis Federal reserve Bank – William Poole – agrees in a new paper:

A straightforward fix for excessive leverage can be achieved through the tax system. Companies borrow, in part, because they believe that debt capital is cheaper than equity capital. That is certainly the case under the U.S. corporate tax system because interest is a deductible business expense in calculating income subject to tax whereas dividends are not deductible.

Excessive leverage is highly destabilizing to the financial system (see this, for example). If a simple fix to the tax code could substantially reduce leverage, I’m all for it.

Poole recommends the gradual phasing-in of changes to the tax code to reduce leverage: