Tax preference for debt leads to over-leveraged economy
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With regards to the treatment of interest as a tax deductible expense, I have no problem. It incentivizes companies to spend money and expand, which is overall very beneficial for the economy as a whole.
It is true that due to various frictions such as the costs of attracting investors, debt may be a more economical form of capital for a business and thus allow faster expansion than the same amount of equity capital, M/M theorem notwithstanding. However, even in the absence of any tax incentives, there is an optimal value for the debt/equity ratio. Too much debt, relative to equity, destabilizes the economy. (I'm sure even the posters that accuse me of being an anti-debt nutjob will agree!)
Your argument assumes that in the absence of tax incentives for debt, the amount of debt used would be below the amount that is macroeconomically optimal.
My question is - why do you believe that to be so?
It is true that due to various frictions such as the costs of attracting investors, debt may be a more economical form of capital for a business and thus allow faster expansion than the same amount of equity capital, M/M theorem notwithstanding. However, even in the absence of any tax incentives, there is an optimal value for the debt/equity ratio. Too much debt, relative to equity, destabilizes the economy. (I'm sure even the posters that accuse me of being an anti-debt nutjob will agree!)
Your argument assumes that in the absence of tax incentives for debt, the amount of debt used would be below the amount that is macroeconomically optimal.
My question is - why do you believe that to be so?
I disagree with the bolded portion. Too much debt without the corresponding ability to pay it back may be destabilizing if companies start going bankrupt, but corporate bankruptcies are not a significant problem at the moment, and there has been a fairly steady decline quarterly of companies seeking either bankruptcy protection or being forced into bankruptcy.
If the tax code were to change tomorrow and interest expense were no longer deductible, I can't speculate as to how or even if companies would change their borrowing behavior. But businesses and governments operate under very different debt ideologies than individuals do. I personally try to avoid debt wherever possible even though I could get tax deductions for mortgage interest, but I don't have an infinite life, just a personal preference to avoid debt wherever I can. Others don't and most people are comfortable with their respective levels of debt.
I disagree with the bolded portion. Too much debt without the corresponding ability to pay it back may be destabilizing if companies start going bankrupt, but corporate bankruptcies are not a significant problem at the moment, and there has been a fairly steady decline quarterly of companies seeking either bankruptcy protection or being forced into bankruptcy.
If the tax code were to change tomorrow and interest expense were no longer deductible, I can't speculate as to how or even if companies would change their borrowing behavior. But businesses and governments operate under very different debt ideologies than individuals do. I personally try to avoid debt wherever possible even though I could get tax deductions for mortgage interest, but I don't have an infinite life, just a personal preference to avoid debt wherever I can. Others don't and most people are comfortable with their respective levels of debt.
It is true that corporate bankruptcies are not a problem at the moment. However, if you wait until you see a lot of them before trying to limit the debt/equity ratio, then you're asking for a repeat of the great crash of 2008.
The right thing to do is to allow for a modest amount of debt, but also to stop encouraging more debt before it starts causing problems, not after symptoms have begun.
I disagree with the bolded portion. Too much debt without the corresponding ability to pay it back may be destabilizing if companies start going bankrupt, but corporate bankruptcies are not a significant problem at the moment, and there has been a fairly steady decline quarterly of companies seeking either bankruptcy protection or being forced into bankruptcy.
If the tax code were to change tomorrow and interest expense were no longer deductible, I can't speculate as to how or even if companies would change their borrowing behavior. But businesses and governments operate under very different debt ideologies than individuals do. I personally try to avoid debt wherever possible even though I could get tax deductions for mortgage interest, but I don't have an infinite life, just a personal preference to avoid debt wherever I can. Others don't and most people are comfortable with their respective levels of debt.
So I am still looking for an argument or data to support the implicit claim that in the absence of tax incentives, the debt/equity ratio of the economy would be below what is optimal to the economy taken as a whole.
I'm not saying I think it isn't or that it is, I'm just curious what your reasoning is.
This analogy is just some fleeting, superficial similarities. Altogether this thread is two things.
1. An incredibly overconfident display of serious misunderstandings of corporate finance; and
2. A poor solution to a non-existent problem.
Clearly you are motivated by some misguided hostility to debt. You really bend over backwards to attempt justifying away valid uses of debt and it shows.
That would be the long and short of it.
Quote:
Originally Posted by ncole1
Ad hominem attack and not a serious point on your part. Please explain what the relevant dissimilarities are.
It's not a non-existent problem when the economy is over-leveraged! If you think it is not, in fact, over-leveraged, please explain your reasoning.
The economy is not "over-leveraged."
I think we already had this discussion on EBIT. What does GAAP say about EBIT?
Nothing, because it is not a recognized accounting method.
Now, let's combine your misunderstanding of EBIT and Corporate Finance.
KRK vs Kroger's
Kroger's made a laughing stock out of KRK.
EBIT Fail #1: Kroger had lots of debt, but Kroger restructured and refinanced its debt.
EBIT Fail #2: Kroger had a positive cash flow, and the restructuring of the debt increased Kroger's cash flow.
EBIT Fail #3: Ever since Barney Kroger had a bank account, the company had always maintained large cash reserves. Kroger's used their cash reserve to buy back their own stock. Kroger's also used their cash reserves to pay down some of their debt to be restructured.
So.....how do you restructure/refinance equity?
There are many advantages to debt. Globally, the corporate situation is very volatile. It would be very easy for US corporations to end up getting taken over by foreign corporations --- like South Korean LG took over Zenith.
Eliminate the interest deduction on debt, and you make many US corporations very vulnerable to hostile take-overs, leveraged buyouts or forces acquisitions/mergers.
Do you see an advantage with foreign ownership of US corporations?
I don't. Personally, I don't care if the Chinese or the Indians or the Haitians buy up all US companies, but from a purely objective stand-point, that would not be in the best interest of the US.
Quote:
Originally Posted by ncole1
The tax evasion argument is an interesting one. I honestly hadn't thought of it but I like it.
I guess I'm now wondering if you think it is more rampant than it was in 1936?
I'm not able to answer that. Speculating, I'm inclined to believe that the apparatus and agencies in place now, such as the SEC may inhibit it, but there's still issues with B/C class stocks and other in-house accounting schemes that might hide assets.
Ask around. Maybe someone with in-depth knowledge of accounting and tax regulations/procedures can give you an accurate answer.
Restructuring...
Again this is simply an attack on motivation (which is irrelevant) and does not address the real issue.
Quote:
Originally Posted by Mircea
The economy is not "over-leveraged."
I think we already had this discussion on EBIT. What does GAAP say about EBIT?
Nothing, because it is not a recognized accounting method.
Now, let's combine your misunderstanding of EBIT and Corporate Finance.
KRK vs Kroger's
Kroger's made a laughing stock out of KRK.
EBIT Fail #1: Kroger had lots of debt, but Kroger restructured and refinanced its debt.
EBIT Fail #2: Kroger had a positive cash flow, and the restructuring of the debt increased Kroger's cash flow.
EBIT Fail #3: Ever since Barney Kroger had a bank account, the company had always maintained large cash reserves. Kroger's used their cash reserve to buy back their own stock. Kroger's also used their cash reserves to pay down some of their debt to be restructured.
So.....how do you restructure/refinance equity?
Well, I don't know the details about this restructuring. However, in general, restructuring of a debt involves changing the terms of the contracts in various ways. Equity does not have any contractually obligated minimum payouts, so it would not need to be "restructured" - rather, investors would simply OK retention of earnings, or sit by the side in disappointment that the company earned less than they expected.
Quote:
Originally Posted by Mircea
There are many advantages to debt. Globally, the corporate situation is very volatile. It would be very easy for US corporations to end up getting taken over by foreign corporations --- like South Korean LG took over Zenith.
Eliminate the interest deduction on debt, and you make many US corporations very vulnerable to hostile take-overs, leveraged buyouts or forces acquisitions/mergers.
That is an interesting point. I'd add to that list, "moving headquarters offshore".
Though a leveraged buyout by definition makes use of debt, so it would only be replacing one debt with another.
Quote:
Originally Posted by Mircea
Do you see an advantage with foreign ownership of US corporations?
I don't. Personally, I don't care if the Chinese or the Indians or the Haitians buy up all US companies, but from a purely objective stand-point, that would not be in the best interest of the US.
I agree.
Quote:
Originally Posted by Mircea
I'm not able to answer that. Speculating, I'm inclined to believe that the apparatus and agencies in place now, such as the SEC may inhibit it, but there's still issues with B/C class stocks and other in-house accounting schemes that might hide assets.
Ask around. Maybe someone with in-depth knowledge of accounting and tax regulations/procedures can give you an accurate answer.
Restructuring...
Mircea
Hmmmm.
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