Comments on: How to reduce the deductibility of interest payments A slice of lime in the soda Sun, 26 Oct 2014 19:05:02 +0000 hourly 1 By: Shaun0720 Tue, 28 Feb 2012 12:02:16 +0000 Hey Felix, just wanted to throw out a positive benefit from encouraging debt financing vis-a-vis equity in case you hadn’t considered it…debt financing implicitly encourages productive use of said financing. If my company raises 10m with no future obligations other than a promise to share a future cut of my profits my behavior is likely to be much different than if that 10m came with the strings attached that I have to pay 11.5m in 10 years time; I’m much more likely to put all of that money to productive use to ensure that I can replay that 11.5m in the future.

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.

By: limapie Mon, 27 Feb 2012 17:07:48 +0000 Dear Mr. Salmon:

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.

By: kenpstack Sun, 26 Feb 2012 16:50:08 +0000 Sure companies pay a reduced tax rate using debt financing as the interest expense is like any other business expense, tax deductible.

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.

By: Gaute Sat, 25 Feb 2012 09:47:31 +0000 If you are a MNE headquartered in the US, and you borrow 100 in the market, put the 100 in as equity in your Belgian daughter, and then borrow the 100 from your Belgian daughter in order to finance investment in another foreign daughter, the US parent company has for tax purpose an interest bearing debt of 200, with all the interest deductible against US income.

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 bstract_id=1791769

By: TFF Fri, 24 Feb 2012 21:53:43 +0000 Felix, you declined to address the “Islamic leasing” program?

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.

By: MyLord Fri, 24 Feb 2012 17:49:25 +0000 Different businesses have different profitabilities. Differing amounts of leverage can allow profitibility equalization between them. This could still be done but to a lesser extent under reduced tax deductibility. The two approaches, limiting leverage and limiting tax deductibility would put debt and equity on a more equal footing but there already are exemptions in corporate tax law that put debt and preferred equity on similar footings so you would also have to change that.

By: Danny_Black Fri, 24 Feb 2012 16:07:24 +0000 Why do we “we have a public interest in encouraging equity rather than debt investment”?

By: KenG_CA Thu, 23 Feb 2012 22:21:11 +0000 TFF, we had the same experience with banks. Profits, 50-100% annual growth, and they would only lend against the equity in my home. And then they put so many conditions on the loan, that if we borrowed anywhere near the amount of our limit, we would be in technical default. They were useless to us, we never used the line of credit (it was a company selling computer hardware products, so it’s not like we had equipment they could put a lien on), and that was BEFORE banks got childish with sub-sub prime mortgages.

By: TFF Thu, 23 Feb 2012 22:00:53 +0000 Eericsonjr, are you talking to me? Or Felix?

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.

By: Eericsonjr Thu, 23 Feb 2012 21:44:04 +0000 Just because you borrow doesn’t mean you don’t have cash. Nothing about debt financing new equipment or any other thing a company needs to grow necessarily means that the company will be over-leveraged. Shouldn’t conflate stupid management with stupid tax policy, even if they do happen to work in parallel.