Home > Uncategorized > Distortion in Tax Code Makes Debt More Attractive to Banks – NYTimes.com

Distortion in Tax Code Makes Debt More Attractive to Banks – NYTimes.com

September 20, 2012 Leave a comment Go to comments

Thanks to a leaked video, we know that Mitt Romney divides the country into those who pay taxes and those who don’t, the makers and the moochers.

There is one perhaps surprising group you can put in the latter category: the nation’s banks. Sure, banks pay taxes, but they pay a lot less thanks to a giant and underappreciated distortion in our nation’s tax code. Moreover, this tax code distortion makes the financial system and the economy more fragile, prone to bankruptcies and runs. Banks profit, and the economy teeters. Great bargain, huh?

It’s the tax code’s favoring of debt over equity.

For businesses, debt interest payments are tax deductible; equity payments, like when a company pays out a dividend, are not. At the margin, this encourages entities to take on more debt than they otherwise would, as Steven M. Davidoff noted in a Deal Professor column earlier this year. More debt not only makes companies more vulnerable to bankruptcy but also makes investors more susceptible to panics, when they withdraw their capital en masse. More equity would make the world more stable.

“The worst thing the tax code can do,” says Victor Fleischer, a tax specialist at the University of Colorado, “is to make it harder to use a sensible capital structure.” Mr. Fleisher, a contributor to The New York Times DealBook, testified in front of Congress last year about this problem.

This distortion is well known. President Obama, in his tax reform proposal, mentioned it, though he didn’t make any specific proposal about what to do about it. The Republican candidate, Mitt Romney, is proposing substantial tax cuts with the loss of revenue made up with the closing of loopholes. He has yet to specify any of those loopholes, but corporate debt interest deductibility hasn’t been in the conversation.

What isn’t well appreciated is how much the debt deduction helps the banks. The first way is direct: Banking is a highly leveraged industry. Banks use more debt than equity to finance their activities. The tax break makes the debt cheaper and encourages banks, at the margin, to gorge on more.

via Distortion in Tax Code Makes Debt More Attractive to Banks – NYTimes.com.

Advertisements
  1. No comments yet.
  1. No trackbacks yet.

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s

%d bloggers like this: