Interest Equalization Tax (IET) Definition

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Interest Equalization Tax (IET) Definition

What Is the Interest Equalization Tax (IET)?

The interest equalization tax (IET) was a federal tax levied on the cost of foreign stocks and bonds purchased by Americans. President John F. Kennedy created the IET in 1963 as a domestic tax policy. The IET was decommissioned in 1974.

The IET was established at the time to reduce the United States’ balance of payments deficit by discouraging investment in foreign assets and promoting investment in domestic securities. The IET made foreign investment less beneficial for US investors. By raising the price of a security, the federal deficit in the balance of payments was reduced by lowering the ratio of capital outflows.

Key Takeaways

  • The interest equalization tax (IET) was a federal tax levied on the cost of foreign stocks and bonds purchased by Americans.
  • The IET was formed as a domestic tax policy by then-President John F. Kennedy in 1963 and was repealed in 1974.
  • The IET was established at the time to reduce the United States’ balance of payments deficit by discouraging investment in foreign assets and promoting investment in domestic securities.

Understanding the Interest Equalization Tax (IET)

The IET taxed differently depending on the kind of stock and the debt obligation associated to it. The IET rate, for example, was 15% on foreign equities and varied from 1.05% to 22.5% on bonds, depending on maturity. The tax rate on the shortest term bonds was the lowest, while the tax rate on the longest duration bonds was the highest. Debt obligations with a term maturity of 3 to 3.5 years were taxed at 2.75% of the purchase price, while debt obligations with a term maturity of 28.5 years were taxed at the original 15% rate.

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The tax was enacted in response to the growing influence of foreign economic activity on the United States. In addition, the levy had the unexpected effect of encouraging activity in the Eurodollar market.

History of the Interest Equalization Tax (IET)

The Interest Equalization Tax was never intended to be a permanent tax instrument. It was supposed to be transitory, yet it lasted longer than expected. The IET was enacted into law on July 18, 1963, with an expiry date of January 1, 1966. It was extended and re-extended many times until finally expiring in 1974. The IET was expected to generate around $30 million for each year it was in operation. With the projected amount—and since the tax was introduced to lower the balance-of-payment deficit—the IET is seen to have served its objective.

Prior to the establishment of the IET, the US balance-of-payment deficit averaged roughly $2.5 billion between 1961 and 1964. The deficit fell dramatically in the years after the implementation of the IET, falling to $1.33 billion by 1966. The deficit increased to $3.5 billion the next year. However, by 1968, the IET had fully eliminated the deficit and replaced it with a $93 million surplus.

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