The editors at Bloomberg point out a good feature in the Republican tax reform plan—treating debt and equity the same for the purposes of taxation. I’ll let them explain it:
One of the biggest defects in the U.S. tax code is that it encourages companies to finance themselves by borrowing rather than by issuing equity. Correcting this bias should be a top priority for President Donald Trump and Republicans in Congress as they merge their plans for tax reform.
The tax preference for debt over equity is neither new nor confined to the U.S., but that doesn’t make it good policy. Many governments treat interest on debt as a deductible expense, so payments to creditors don’t get taxed while payments to shareholders do. This tilting of incentives has no good justification and can be dangerous.
Highly leveraged enterprises are much more likely to fail in an economic downturn. This fragility is what turns isolated asset bubbles into major catastrophes. It’s why the subprime boom of the 2000s, financed largely with credit, was so much more damaging than the equity-fueled dot-com craze of the 1990s.
While the best approach would be to eliminate the corporate income tax entirely, if you’re going to maintain a corporate tax system (which appears to be a political necessity), allow companies to deduct the equity issued as an expense.
That sounds good to me but I’m no expert on corporate finance and would appreciate any commentary by people who are.
Eliminating the corporate tax would be fine, but not for the reasons discussed here. This:
“Highly leveraged enterprises are much more likely to fail in an economic downturn. This fragility is what turns isolated asset bubbles into major catastrophes. It’s why the subprime boom of the 2000s, financed largely with credit, was so much more damaging than the equity-fueled dot-com craze of the 1990s”
Is just inane. This would eliminate purchase of big ticket corporate durables, and homes, for all except people like me. Startups are equity financed because they are not debt worthy, not tax efficient. Homes are time financed because few can save the purchase price in cash.
One could say that debt service should have no tax impact. That’s fine. That would simply increase the cost of capital. Better phase that in slowly. But companies, as posited, don’t default because of interest, they default because of decline of profitability. Further, as anyone who has been through workouts knows, the ability to pay the meter on money, if not principle, is useful. Melding debt and equity would have an unintended consequence, and result in faster moves to accelerate and liquidate enterprises.
Thanks. That’s not stuff that’s visible to me.
This piece clarifies that Trump’s Russophobic belittlers whether in government or those miscreants cheering the police staters on, are playing a key role in thwarting Trump’s worker-friendly economic plans.
https://www.bloomberg.com/view/articles/2017-03-22/trump-s-misplaced-priorities-imperil-his-economic-agenda