Tax Policy Challenges in the 21st Century

S. 222I. Introduction

Excessive risk-taking by financial institutions is considered to be the main cause of the global financial crisis that took place in 2007-2008. One of the main reasons was that before the crisis, banks had invested heavily in asset-backed securities, the risk of which was heavily underestimated and which had increased short-term borrowing for funding. In this economic environment, once real estate and consumer credit markets weakened, the prices of asset-backed securities collapsed, with high losses that quickly wiped out the equity capital of many banks. It also led to great uncertainty about their solvency because their counterparts froze overnight borrowing.

To avoid a collapse of the entire financial system, interventions by governments such as providing credit lines, loan guarantees and equity injections were necessary. The collapse of the financial system was avoided at great cost. The crisis spread to the real economy, because banks reduced lending to businesses. These facts gave evidence that distressed banks create significant costs for taxpayers as well as non-financial institutions; it also created a heated debate on government intervention in the financial...