Tax preference for debt leads to over-leveraged economy (credit card, companies, interest)
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You are assuming that corporations are not excessively leveraged in order to argue that they aren't excessively leveraged - thus, this is a circular argument.
I just said that the system is overleveraged. That included the banking system and the homeowners as well as the public corporations. You just ignored the rest of the post that detailed how the regulators pushed for the system to take on more leverage. I can give many more examples. How about credit default swaps? They passed laws to protect credit default swaps from regulation. This enabled banks to buy debt with 100% leverage under the assumption that credit default swaps gave them protection from losses. Of course, we know that this was a lie and the government was there to pick up the pieces. A big part of the problem causing the debt buildup is the assumption on the part of the large corporations that the government will bail them out.....
And? Maybe you don't like the point even though it's a valid point. The leverage/debt can be retired while my ownership stays the same. Having a discussion with you is nearly pointless unless someone sees everything your side.
It's not "my side" - it is a topic that a lot of professional economists and those in academia have written about, starting with Modigliani and Miller and also including the paper I referenced in OP. The basic idea, in case you don't understand it already, is that a rational investor should demand a higher return on equity in a highly leveraged firm than he/she does in a less-leveraged firm, in order to compensate for the increased volatility and risk. This demand is such that, under a certain set of assumptions, the value of the debt plus the equity of a firm should not depend on its capital structure.
A secondary result is that the rational valuation of the benefit of leverage should be equal to, but opposite, the rational valuation of the increased volatility, under the same set of assumptions. While not all of these assumptions are exactly true in the real world, it is useful to invoke the M/M theorem insofar as it shows that a preference for one type of capital must be due to the deviation of the "real world" from the assumptions of the theorem.
I just said that the system is overleveraged. That included the banking system and the homeowners as well as the public corporations. You just ignored the rest of the post that detailed how the regulators pushed for the system to take on more leverage. I can give many more examples. How about credit default swaps? They passed laws to protect credit default swaps from regulation. This enabled banks to buy debt with 100% leverage under the assumption that credit default swaps gave them protection from losses. Of course, we know that this was a lie and the government was there to pick up the pieces. A big part of the problem causing the debt buildup is the assumption on the part of the large corporations that the government will bail them out.....
So then the question is how to discourage the over-leveraging. The paper I reference in the OP makes the case that changes in the tax code are a good idea. If you don't believe this to be so, then what flaws do you see with the argument?
Yes, on the basic point we agree, I just thought your earlier statement was phrased strangely.
Okay.
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Originally Posted by ncole1
How does the priority of bondholders in a liquidation justify interest deductibility?
The justification is whether the interest is a necessary business expense. Under the tax code we try to match expenses with revenues. If a company has an expense, but that expense leads to higher revenue then there are more taxes paid and that makes the USGOV happy, happy, happy.
Shareholders and bondholders cannot be treated as the same because they aren't the same. With bonds or loans the corporation has a legal obligation to return the principal and interest on a set schedule, but there are no such obligations to shareholders.
Quote:
Originally Posted by ncole1
No, I'm in favor of either removing interest deduction or adding dividend deduction, but not both.
I just suspect that phasing out interest deductibility is preferable, because "hiking tax rates" is very difficult to do for political reasons! (If only more voters understood economic theory.....)
Okay, but then the issue you have with the current tax code isn't really with the interest deduction.
Quote:
Originally Posted by ncole1
How is this relevant? These solutions are not mutually exclusive with what I am discussing here.
They aren't, but you seemed concerned with over-leverage. My point is there are ways to address too much leverage.
Quote:
Originally Posted by ncole1
Dividends cannot be expensed.
Sure, but dividend taxation is a different conversation and there may be reasons the US does not allow that...or not. In general though, expenses are allowed to be deducted.
It's not "my side" - it is a topic that a lot of professional economists and those in academia have written about, starting with Modigliani and Miller and also including the paper I referenced in OP. The basic idea, in case you don't understand it already, is that a rational investor should demand a higher return on equity in a highly leveraged firm than he/she does in a less-leveraged firm, in order to compensate for the increased volatility and risk. This demand is such that, under a certain set of assumptions, the value of the debt plus the equity of a firm should not depend on its capital structure.
A secondary result is that the rational valuation of the benefit of leverage should be equal to, but opposite, the rational valuation of the increased volatility, under the same set of assumptions. While not all of these assumptions are exactly true in the real world, it is useful to invoke the M/M theorem insofar as it shows that a preference for one type of capital must be due to the deviation of the "real world" from the assumptions of the theorem.
Like I said its pointless to have a discussion with you. Some owners care about maintaining their ownership % over dilution. Debt can be a more flexible tool for a company to use vs issuing secondaries and then buying back stock. Again you will respond with another few paragraphs that ignore reality and bring us back to a unproductive discussion
They aren't, but you seemed concerned with over-leverage. My point is there are ways to address too much leverage.
Yes, and I am discussing one such way of doing it. The mere fact that there are other possible ways of solving a problem is not a reason by itself not to do something!
Like I said its pointless to have a discussion with you. Some owners care about maintaining their ownership % over dilution. Debt can be a more flexible tool for a company to use vs issuing secondaries and then buying back stock. Again you will respond with another few paragraphs that ignore reality and bring us back to a unproductive discussion
How is the fact that some owners prefer leverage an argument to incentivize even more leverage?
Yes, and I am discussing one such way of doing it. The mere fact that there are other possible ways of solving a problem is not a reason by itself not to do something!
When the course of action you are proposing has negative consequences there very much is a reason not to do something. Especially when the current tools available are more efficient at addressing leveraged risk.
When the course of action you are proposing has negative consequences there very much is a reason not to do something. Especially when the current tools available are more efficient at addressing leveraged risk.
How is the fact that some owners prefer leverage an argument to incentivize even more leverage?
It's not. Go back to the post I originally quoted you when you were discussing the debt/equity mix and notice I originally said ignoring the tax issues that debt could be preferred over equity. The are many other reasons other than a tax advantage. Was is not clear when I said "with no tax consideration"? You probably missed it in your attempt to formulate a great retort
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