In February, President Obama said “Companies are taxed heavily for making investments with equity; yet the tax code actually pays companies to invest using leverage”. And he is right: the corporate tax code in the United States creates a significant bias toward debt finance over equity.
Of course, the U.S. is not unique. In most of Europe, Asia and elsewhere in the world, the tax advantages of debt finance are even bigger than in the U.S.
The crux of the issue is that interest paid on borrowing can be deducted from the corporate tax bill, while returns paid on equity—dividends and capital gains—cannot.
The debt distortion is not new. What is new, however, is that we have come to realize that excessive debt (or leverage) is much more costly than we have always thought. Continue reading
Filed under: Advanced Economies, Financial Crisis, Fiscal policy, International Monetary Fund | Tagged: capital gains, corporate income tax, corporate profits, debt bias, debt finance, dividends, equity, financial crises, global financial crisis, interest deductiblity, investment, leverage, tax avoidance, tax deduction, tax incentives | Leave a comment »