Interest Equalization Tax was a domestic tax measure implemented by U.S. President John F. Kennedy in July 1963. It was meant to make it less profitable for U.S. investors to invest abroad by taxing the purchase of foreign securities. The design of the tax was to reduce the balance-of-payment deficit. Although it was originally intended to be a temporary tax, it lasted until 1974. It raised cost of borrowing in U.S
Purpose
The purpose of the tax was to decrease the balance of payments deficit in the US. This was achieved conceptually by making investments in foreign securities less appealing. By increasing the price of the security, investors will buy fewer of them, all else equal. With fewer domestic investors purchasing foreign securities, capital outflows will be lower, thereby reducing the balance-of-payments deficit. The equation for the balance of payments is: The identity for the capital account is: So when capital outflows decrease, the capital account increases. When the capital account increases, the balance-of-payments increases.
Dates Effective
The tax was effective on purchases made after July 18, 1963. It was scheduled to expire on January 1, 1966, but was extended multiple times, and eventually abolished on January, 1974.
Amount of the tax
For foreign stocks, the tax is 15% of the price
For debt obligations there is a range between the following bounds:
For debt obligations having 3 to 3.5 years remaining until maturity, the tax is 2.75% of purchase price
For debt obligations having 28.5 years remaining until maturity, the tax is 15% of purchase price
Exemptions
Debt obligations with less than 3 years remaining until maturity
Debt obligations that were issued to a U.S. person in order for that foreign corporation to purchase U.S.-produced goods
Foreign securities that would endanger international monetary stability. The President will determine if any foreign securities qualify for this exemption. Canadian-issued securities were the only initial exemption from the tax in 1963
Since many factors influence the balance-of-payments account, the effect of the tax is unclear. However, there was a positive trend in the years after it was enacted.
The interest equalization tax "brought American investment activity in foreign markets to a virtual standstill." However, financial markets responded over time with massive evasion of the tax, along with the development of the eurodollar market.
