Tax Analysts Blog

More Talk about Limiting Corporate Interest Deductions

Posted on Jan 30, 2012

Is it just a coincidence? Or is there growing interest in limiting interest deductions on corporate debt? My prior post made the case. And over the last few days there has been a lot of supportive talk from a variety of sources for limiting interest deductions . First, the latest issue of The Economist stated:

    [T]hough the private-equity people may have walked off with the loot, America’s tax code was partly to blame, because it encourages this behaviour. The tax deductibility of interest payments on debt gives private-equity executives an incentive to pile extra debt onto the companies they buy, thereby risking the health of these firms for the sake of a tax benefit and the prospect of higher returns.

Second, on Bloomberg William D. Cohan ("Private Equity’s Public Subsidy Is a Tragedy") wrote:
    Since corporate debt is the mother’s milk of a leveraged buyout, there would be no private-equity/LBO industry without this huge tax benefit. Indeed, anyone who has used an Excel spreadsheet to model a leveraged-buyout -- you know who you are! -- knows that the magic of the entire industry depends almost solely on the interest-expense provision in the tax code.

Third, conservative economist Alex Brill at the American Enterprise Institute--and formerly with the Republican staff of the Ways and Means Committee--issued his plan for corporate tax reform that would reduce interest deductions by 10 percent. He argues:
    [E]xcessive leverage induced by the tax subsidy for debt financing may lead to more volatile business cycles and greater risk of a financial crisis affecting the economy.

Finally, just in case you thought this was a partisan issue, John Buckley, professor of law at Georgetown--and formerly with the Democratic staff of the Ways and Means Committee--stated at a recent Tax Analysts roundtable:
    To get to 25 percent, you have to do other things [than eliminate tax expenditures] and the other candidates, are clear to me. [They are] the interest deduction and advertising expenses. Those are the only other items of large revenue that would have to be used in the tax reform plan focused on a 25 percent [corporate] rate.
In 2008 Germany adopted new tax rules that limited interest deductions when net interest exceeded an expanded definition of income. Will the United States follow Germany's lead? Will Obama propose a limit on interest deduction as part of his tax reform framework that will be released in mid-February?

POSTSCRIPT (Jan 30, 2012, 2:01pm): From the lead editorial in today's Financial Times:
    . . . the system could be made fairer and more efficient by taxing debt and equity at the same rate . . . . Most of [Romney's] money was made at Bain Capital, which, like all private equity groups, benefits from a federal debt subsidy. It should be eliminated.

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