Pete Davis makes what I think is a very interesting observation that, as long as interest is deductible by companies and equity income is taxed, then you are subsidizing debt at the expense of actual growth in the underlying enterprise.
Pete Davis makes what I think is a very interesting observation that, as long as interest is deductible by companies and equity income is taxed, then you are subsidizing debt at the expense of actual growth in the underlying enterprise.
The issue is a lot more complicated than Mr. Davis would have you believe. I found his commentary to be banal, if not simplistic. He leaves out the crucial concepts of cost of capital and risk adjusted returns.
Suppose you want to finance an acquisition or perhaps the acquisition of a capital asset. You can do that with debt or with equity. Let’s suppose a senior lender will provide financing at 6.5%. After the tax subsidy that might be 4%. Now depending on whether you’re a private equity guy, or corporate guy, the required returns on equity might range from the mid teens for the corporate guy to over 20% for the private equity guy. Even after factoring in capital gains tax rates it’s obvious on its face the debt financing provides a lower cost of capital, and enhances the returns to the project.
Mr. Davis is out to lunch.
Now, let me be clear, I am a guy who would like to see the taxes on equity gains be reduced to zero. After all, equity capital has already been taxed once, it’s accumulated wealth, and it’s the lifeblood of investment and future growth. If Mr. Davis had gone down that path I would have been an unabashed supporter. But to contrast the tax subsidy for debt versus the tax rate on equity, and to ascribe the finacial calamity on this, is just absurd.
I’ve never understood the almost absolute abhorence of debt. Debt is nothing more than reducing future consumption so that you can consume today. A business person might call it investment and such, but in the end it is pretty much the same. The problem is if the incentives get screwed up that you do either too much or too little. Like most things in life, you have to watch out for the extremes.