This isn’t intended to be a defense of the status quo; I don’t think 100% deduction is optimal (of justified) and I am very much in favor of that discussion you speak of. I just wanted to point out that I think wise public policy should indeed encourage debt financing over equity financing to a certain extent for this structural framework to encourage productivity.

Thanks for all of your great work.

A good place to start discussion is to examine where
this whole idea of deducting interest started.

What was the reasoning for instituting this provision
in the tax code to begin with?

From my limited knowledge, I’m thinking that
maybe this idea might have been put into place because
the gov wanted to give a poor person the opportunity
to borrow money and start a business. If the gov
gave them a break, they could do it. If the gov
didn’t do this, then only filthy rich people could
swing in the ownership circles.

From my limited knowledge, I’m thinking that the
filthy rich abused the gov help provision. And if this was the case, then maybe you are correct…take the opportunity away from those that abused a break for the little guy.

But then, you’re running into this thing that has been the foundation of the Obama administration….unequality
for everyone…this person should be treated differently from that person based on some governmentally dreamed up definition. I’m getting absolutely totally sick of
this fueling of internal war…it certainly isn’t deserving of ANY peace prize. AND worse! The administration comes out and twists this bigotry as if it is all American, equal equal stuff when the truth is
that it’ll crumble our society.

Debt financing allows risk to be taken. The author’s premise that corporate debt financing contributes to systemic risk and economic crisis is wrong with no historical precedent.

The return to a company and thus a company’s shareholders increases when leverage is increased. Leverage has gotten a bad verdict in the court of public opinion due to the 2008 global economic crisis and rightfully so as the use of derivatives increased financial institutions leverage to disturbing levels. It was banks that engaged in excessive leverage, one sector, not corporations in general.

In the 2008 crisis individual companies were not guilty of excessive leverage, it was..
1) financial institutions through derivatives and creating an unhealthy volume of securitization: risky loans packed together called collaterized debt obligations (CDOs) and…
2) individuals themselves following through on home loans they could not meet the obligations of and did not understand in some cases.

So go ahead and discourage debt financing and you will discourage economic activity without addressing the actual cause of global economic risk. Still concerned? Put pressure on government to implement a greater % of the Dodd Frank legislation which addresses the actual systemic issues of risk better than the tax treatment of debt.

Don’t penalize those that take the financial risk with debt financing to supply jobs and earn a profit here in the U.S.

Not now anyway.

The Belgian company has a taxable income of 100. But the Belgians have created a special “Notional Interest Deduction” (NID) tax system in order to attract financial activity from MNEs. They get a notional interest deduction in Belgium on the 100 they received as equity from the US parent, leaving no taxable income there.

One easy way to stop this kind of erosion of the US tax base is to introduce a cap on financial deductions, like for instance Germany has done. It may be linked to EBITDA or some similar financial number, disallowing deductions for net financial costs exceeding some percentage of this.

Debt structuring is one of the easiest ways to eliminate taxable income in MNEs. If you want to know more in depth about this, a good place to start is Kleinbard’s excellent recent paper “Stateless Income” which you may download here http://papers.ssrn.com/sol3/papers.cfm?a bstract_id=1791769

If interest paid is not deductible for banks, then you’ve dramatically changed the rules of play. I doubt you’ve thought through the implications of that one. (I doubt you are able to think through such a major change successfully.)

If interest paid *is* deductible for banks, but not for other corporations, then you simply shift from borrowing money to “leasing”. Good for banks (since they can effectively arbitrage the tax law), but not good for society as a whole.

We need to get away from taxing corporate income anyways. It doesn’t work (too many ways for multinationals to dodge) and it won’t ever be fair. the cash out, not the cash in.

Like KenG, my brother had much of his “earnings” tied up in receivables. That happens when a business is growing fast. And he did borrow — but banks aren’t all that eager to float $100 grand to a small company only a couple years old, even if business is booming.

Even intelligently managed companies (and I suspect most have a few operational road bumps as they grow) can be short on cash.

I think my brother has switched. :) But there were a couple years that he needed a six month extension to make his tax bill. Kind of ridiculous given his nominal earnings at the time, and I shuddered at the debt he was racking up. Guess it all worked out in the end for him… As you say, it doesn’t seem to be an unusual story.

“I’m not an accountant but I once ran a corporation and I’m mystified by this. I don’t recall the government rebating 60% of my interest costs.”

Accelerated depreciation, perhaps? Over the past five years there have been a bunch of ideas implemented to try to get people to invest. It is almost to the point where the government will finance it for you! (Except you need to carry the debt on your books for a few years, and you still need to pay back the principal.)

WTF? I’m not an accountant but I once ran a corporation and I’m mystified by this. I don’t recall the government rebating 60% of my interest costs. I was able to deduct interest, but the money wasn’t free by any means, precisely because I had to pay interest on it.

If interest is not 100% deductible, then a business that has zero profit after interest payments will still have taxes due and thus be in danger of bankruptcy, so the change you propose would make the system more fragile. Unless businesses reacted to this danger by reducing borrowing, which seems to be your overall goal. But then we get the Islammic issue someone aluded to, where people come up with all sorts of stock-bond hybrids to game the system.

Also, as others have noted, the real problem is double taxation of profits and dividends.

If the governments want more money from interest, then get rid of some of the tax exemptions which allow persons or entities to receive interest without being taxed on it: non-profits, pension funds, Roth IRAs, foreigners who receive interest (and also dividends) from US payers without paying taxes, municipal bonds, etc.

More broadly, removing or limiting tax deductibility of interest would create our own version of an Islamic finance industry – ongoing efforts to structure transactions to relabel what’s really “interest” as some other type of expense.

And then to make it worse, the S corp classification cost me a lot of money, for although the company had a successful “exit”, when I re-invested the capital gains in new ventures, the investments were not excluded from capitals gains tax, as they would have been if it were not an S corp. Lesson to anyone starting a company that they hope to grow: don’t use S corp classification.