The time value of money, measured by the interest rate at which an entity can borrow or invest, plays an incredibly important role in income tax. Every tax teacher emphasizes the value of deferral to taxpayers, explaining that paying a dollar of tax  10 years in the future is worth much less than paying a dollar of tax today, because the taxpayer can invest less than a dollar today, earn interest for 10 years, and then pay the tax obligation.

But, as I explain in my recent short article, “How to Think About and Teach Income Tax When Interest Rates Are Zero,” the time value of money is much less than it used to be. For many governments, money has no time value. They can borrow at zero, or near-zero, interest rates. For example, a Euro in taxes paid in 10 years is worth the same to the German government as a Euro in taxes paid today. The same is true for the Japanese government. Even in the United States, which has the highest interest rates in the G7 group of nations, a dollar in taxes paid 10 years from now is worth 86 cents today (at an interest rate of 1.57 percent, the 10 year U.S. Treasury yield on August 16, 2016).

Many taxpayers also face interest rates close to zero. For example, the current average yield of a double-A rated corporate bond maturing in five years is 1.37 percent. For a double A-rated corporation, a dollar in taxes owed in five years is thus worth 93 cents today. Deferral is just not that valuable.

Near-zero interest rates can no longer be considered an idiosyncratic event. Short term interest rates have been zero or near-zero in most industrialized countries for five years or longer. In a near-zero interest rate environment, it’s not worth obsessing over finding or eliminating opportunities for tax deferral—as we teach our students to do.

The diminished time value of money has implications for almost every issue in income tax, from the broad (should we use an income tax or a consumption tax to raise revenue?) to the narrow (how should the rules of Section 1272 of the Internal Revenue Code apply to zero coupon bonds?).

Tax scholars and policy wonks have for generations been advocating that a consumption tax replace an income tax. Income taxes are inferior to consumption taxes, because they discriminate against savings. With an income tax, savings gets taxed twice – once when the income is earned through labor and again as the savings earns a rate of return.  A consumption tax, by contrast, taxes everything once (at the time of consumption). The distortion induced by the income tax, however, goes away if savings doesn’t earn an annual return—a condition that holds (approximately) today. Thus, much of the supposed benefit of a consumption tax over an income tax simply does not apply in the present era of near-zero interest rates. Today’s consumption tax advocates need to explain why a consumption tax is superior under present conditions rather than rehashing arguments formulated at a time when interest rates were much higher.

It’s not just a consumption tax that needs to be rethought with interest rates at their current lows. Some rules designed to mitigate opportunities for tax deferral when interest rates were much higher should be reconsidered in this era of near zero interest rates.  For example, the Original Issue Discount (OID) rules of Section 1272 of the Internal Revenue Code impute income to zero coupon bonds in order to limit deferral. The OID rules are very complex and impose significant administrative burdens on transactions. But the OID rules are probably not worth their costs when deferral costs the Treasury so little. Section 1272 should be suspended if the imputed interest rate is low enough.

While deferral diminishes in importance with zero interest rates, policies that impose tax rates that differ over time become more important. In a near-zero interest rate environment, tax planners will spend more effort trying to get income taxed at a lower rate and less effort simply deferring taxes.

The U.S. tax obligation incurred by multinational U.S. corporations on offshore earnings provides a good example of the importance of differential tax rates in a zero interest rate world. Under the U.S. income tax, income earned by foreign subsidiaries of U.S. companies is subject to U.S. taxation. The income is not taxed by the U.S. when earned. Instead, the income is taxed when it is repatriated into the U.S., which could be years later.  With the time value of money so low, we might expect U.S. corporations not to bother with keeping money offshore or booking profits overseas rather than in the U.S. The present discounted value of the tax owed on any future repatriation is not much less than the value of paying the tax now.

But this is not what we see. U.S. multinational corporations retain vast un-repatriated overseas profits. Why? It’s not for the interest savings. Instead, I think that corporations hope for a repeat of 2004. In that year, the U.S. government enacted a repatriation tax holiday that enabled multinationals to repatriate foreign profits without paying any U.S. tax. It makes sense for corporations to keep profit abroad if waiting may eliminate tax obligations entirely.  Thus, the importance of a repatriation tax holiday as a tax planning matter grows when interest rates are near zero. The prospect of a holiday induces non-repatriation of foreign earnings when interest rates would not provide a strong incentive to keep money abroad. Policymakers need to keep the interest rate environment in mind when they make tax-rate decisions.

This post comes to us from Professor Yair Listokin of Yale Law School. It is based on his recent article, “How to Think About and Teach Income Tax When Interest Rates are Zero,” available here.