What Is the Interest Equalization Tax?

The interest equalization tax (IET) was a federal levy on the purchase price on 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 outflow.

Key Takeaways

  • The interest equalization tax (IET) was a federal levy on the purchase price on 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

The IET had different tax amounts based on the kind of stock and the debt obligation attached to it. 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 28.5 years term maturity on them carried the original 15% tax rate.

The 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

The Interest equalization tax was never meant to be a long-lasting tax measure. It was meant to be temporary—it 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 abolishment in 1974. The IET was anticipated to raise an approximate sum of $30 million for each year it was in effect. With the anticipated amount—and because the tax was established as a way to reduce the balance-of-payment deficit—overall, the IET is considered to have worked for its intended purpose.

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 $1.1. billion by 1966. The following year, the deficit rose to even more, at $3.5 billion. But by 1968, the IET had abolished the deficit completely and replaced it with a surplus of $93 million.