Republicans looking to rewrite the U.S. tax code are taking aim at one of the foundations of modern finance—the deduction that companies get for interest they pay on debt.
That deduction affects everyone from titans of Wall Street who load up on junk bonds to pay for multi billion-dollar corporate takeovers to wheat farmers in the Midwest looking to make ends meet before harvest. Yet a House Republican proposal to eliminate the deduction has gotten relatively little sustained public attention or lobbying pressure.
Thanks in part to the deduction, the U.S. financial system is heavily oriented toward debt, which because of the tax code is often cheaper than equity financing—such as sales of stock. It also is widely accessible. In 2015, U.S. businesses paid in all $1.3 trillion in gross interest, according to Commerce Department data, equal in magnitude to the total economic output of Australia.
Getting rid of the deduction for net interest expense, as House Republicans propose, would alter finance. It also would generate about $1.5 trillion in revenue for the government over a decade, according to the Tax Foundation, a conservative-leaning think thank.
The plan would raise money to help offset Republicans’ corporate tax cuts and reduce a “huge bias” toward debt financing, said Robert Pozen, a senior lecturer at MIT’s Sloan School of Management. That bias, he said, hurts companies built around innovation, which tend to not have the physical assets that banks usually require as collateral.
In a world with no interest deduction, debt-fueled leveraged buyouts by private-equity titans could become more expensive to finance and junk bonds less appealing. “That’s not necessarily bad for society,” said David Beim, a retired Columbia University finance professor. “We have too much systemic financial risk in our economy.”
For some debt-reliant businesses, the interest deduction’s demise could be a blow. Crop growers who depend on bridge loans to work through seasonal business fluctuations could face higher tax bills.
Midsize businesses may also get squeezed.
“The people that utilize debt, they utilize it because they don’t have the cash and they don’t have the access to equity,” said Robert Moskovitz, chief financial officer of Leaf Commercial Capital, which finances businesses’ purchases of items like copiers and telephone systems. “A dry cleaner in Des Moines, Iowa? Where is he going to get equity? He can’t do an IPO.”
The idea behind the Republican plan is to pair the elimination of this deduction with immediate deductions for investments in equipment and other long-lived assets. Party leaders expect the capital write-offs would encourage more investment and growth and greater worker productivity, but not the debt often associated with it.
From an accounting standpoint, the tradeoff could hurt companies’ reported earnings because immediate expensing would just shift the timing of deductions and the loss of the interest deduction would be a permanent change. Read more at WSJ.