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What Is the Interest Equalization Tax (IET)?
The interest equalization tax (IET) was a federal levy on the purchase price of foreign stocks and bonds bought by Americans. The IET was established in 1963 as a domestic tax measure by then-President John F. Kennedy. The IET was eliminated in 1974.
At the time it was introduced, the IET was designed to decrease the U.S. balance of payments deficit by discouraging investment in foreign securities and encouraging investment in domestic securities. The IET made it less profitable for U.S. investors to invest abroad. By increasing the price of a security, it was also meant to reduce the federal deficit in the balance-of-payment by bringing down the ratio of capital outflows.
Key Takeaways
- The interest equalization tax (IET) was a federal levy on the purchase price of foreign stocks and bonds bought by Americans.
- The IET was established in 1963 as a domestic tax measure by then-President John F. Kennedy; it was eliminated in 1974.
- At the time it was introduced, the IET was designed to decrease the U.S. balance of payments deficit by discouraging investment in foreign securities and encouraging investment in domestic securities.
Understanding the Interest Equalization Tax (IET)
IET rates varied based on stock type and debt obligations. For example, the IET rate was 15% on foreign stocks, and it ranged from 1.05% to 22.5% on bonds, depending on their maturity. The shortest maturity bonds had the lowest tax rate and the longest maturity bonds had the highest tax rate. Debt obligations that had 3 to 3.5 years until stock maturity were taxed at 2.75% of the purchase price, while debt obligations with a 28.5-year term maturity on them carried a 15% tax rate.
The IET tax was one result of the increasing impact of international economic activities on the United States. The tax also had the unintended consequence of increasing activity in the Eurodollar market.
History of the Interest Equalization Tax (IET)
The IET was never meant to be a long-lasting tax measure. It was intended to be temporary and actually lasted longer than previously anticipated. When the IET was first signed into law on July 18, 1963, it contained an expiration date of January 1, 1966. It was extended and re-extended multiple times until its final expiration in 1974. The IET was anticipated to raise an approximate sum of $30 million for each year it was in effect.
Before the IET was established, in the years between 1961 and 1964, the US balance-of-payment deficit was averaging around $2.5 billion. In the years right after the IET was put into effect, the deficit dropped significantly, to $1.3. billion by 1966. The following year, the deficit rose again to $3.5 billion. But by 1968, the IET had abolished the deficit completely and replaced it with a surplus of $93 million.
The IET is considered to have worked for its intended purpose.
What Is Balance of Payments?
Generally speaking, the balance of payments deficit is a metric measuring the difference between the amount of capital flowing into and out of a country in a given period. Transactions that factor into calculating a country’s balance of payments include imports and exports of goods, services, and capital, as well as transfer payments.
What Is Balance of Payments Deficit?
In common parlance, a balance of payments deficit occurs when a country cannot fund its imports solely through the capital raised through exports. In such cases, it may need to draw down its reserves, resulting in a balance of payments deficit.
How Many Times Was IET Extended?
The IET was imposed as a one-time measure, aimed at increasing investment in domestic securities while disincentivizing investment in foreign securities. The levy effectively made it less attractive for American investors purchase foreign bonds or stocks. Due to its success, it was kept in place much longer than initially intended. Ultimately, IET was extended six times.
The Bottom Line
The IET was a federal levy on the purchase price of foreign stocks and bonds. It was in effect between 1963 and 1974. The levy was introduced with the aim of reducing the federal balance-of-payment deficit. This metric hovered around $2.5 billion when the levy was first put in place. By the time it was lifted, the IET was considered to have achieved its goal.