Wall Street Journal, Potential Tax Change Is Red Flag for Some Firms, by John D. McKinnon:
Lawmakers are considering adjustments to a fundamental feature of the U.S. tax code that could have a profound effect on how companies finance their operations. Specifically, members of Congress are focusing on code provisions that encourage companies to finance their activities through issuing debt, instead of equity. The most basic is the tax deduction typically allowed for interest payments on business debt. The lawmakers’ move, though embryonic, is raising red flags for some businesses that use lots of leverage, including financial firms and manufacturers, but offering hope of lower tax rates for many others.
The chairmen of the Senate Finance Committee and House Ways and Means Committee have asked for a study of how debt is taxed, and whether that contributes to over-leveraging by businesses and households.
From the mid-1990s to 2008, business-sector debt grew far faster than gross domestic product, hitting more than $25 trillion by one measure, before declining.
A 2010 report by a panel of outside advisers to President Barack Obama listed a change in the tax treatment of debt among the main options for a corporate tax overhaul, saying it could reduce “leverage of firms and the likelihood of future financial distress.”
Favorable tax treatment makes debt-financed investments more attractive for companies than investments financed by equity, or the company’s money, and is one reason for the rapid growth in debt in some sectors in the run-up to the meltdown, many experts believe. Debt has become so widely used in corporate America that some large companies now are even borrowing the money they need to pay dividends.
Tax experts have suggested that some investors can use debt deductions to make money, by borrowing to buy items that enjoy other tax breaks, such as accelerated depreciation. For certain firms and certain investments, “the effective marginal tax rate on debt-financed investment is negative,” the White House study warned last year.
