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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
Poor communication. I apologize for misunderstanding your post and I agree with you.
You would kill corporate America's profits as they would either have to pay tax on the interest payments or retire the debt which would deplete their retained earnings account.
You would make it more difficult for smaller companies to grow as they could only grow via an equity infusion from an outside party or with their retained earnings, but could not grow via financing.
As companies would have to self finance their actions the economy would slow down.
You would kill corporate America's profits as they would either have to pay tax on the interest payments or retire the debt which would deplete their retained earnings account.
Good point. How about a reduction in the overall tax rates to compensate?
Quote:
Originally Posted by lycos679
You would make it more difficult for smaller companies to grow as they could only grow via an equity infusion from an outside party or with their retained earnings, but could not grow via financing.
Why not? If both debt and equity were double taxed how does this make corporations use equity when they otherwise would use debt?
Quote:
Originally Posted by lycos679
As companies would have to self finance their actions the economy would slow down.
Good point. How about a reduction in the overall tax rates to compensate?
I don't think that would be enough. If a company has $100K in interest payments they would now have to come up with 20%, 30%, XYZ% to pay the tax and that is money they may not have available. Plus, the interest is already going to be taxed as earnings/income when received by the shareholder.
Quote:
Originally Posted by ncole1
Why not? If both debt and equity were double taxed how does this make corporations use equity when they otherwise would use debt?
The interest would no longer be deductible, but would be a required payment (while dividends are not) so the usage of debt would be discouraged. Equity isn't taxed though. Earnings and dividends of C corps are taxed. An S corp shareholder would not pay any taxes on dividends they receive.
I don't think that would be enough. If a company has $100K in interest payments they would now have to come up with 20%, 30%, XYZ% to pay the tax and that is money they may not have available.
This is why I said to phase out over 20 years rather than suddenly changing the rules. Of course a sudden change would shock the system and is a bad idea - I fully agree with you there.
Quote:
Originally Posted by lycos679
Plus, the interest is already going to be taxed as earnings/income when received by the shareholder.
You mean the bondholder? Sure, but dividends are already double taxed, why not put them on an equal tax footing?
Quote:
Originally Posted by lycos679
The interest would no longer be deductible, but would be a required payment (while dividends are not) so the usage of debt would be discouraged.
I don't see why the fact that the payment is required matters much*, unless the corporation has so much debt that it is at a high risk of default, in which case this is precisely when we should not be encouraging debt as it already has too much!
*The exception would be if the corporation has a new, highly capital-intensive project available in the immediate future.
Quote:
Originally Posted by lycos679
Equity isn't taxed though. Earnings and dividends of C corps are taxed. An S corp shareholder would not pay any taxes on dividends they receive.
For individuals, the tax code is a lot less debt incentivizing than it used to be. Once upon a time, credit card interest and auto loans were itemized deductions.
Joseph B. Allen argues in the paper, Seeking True Financial Reform: Ending the Debt-Equity
Distinction , that Congress failed to learn from the recent financial crisis the importance of keeping leverage under control.
Allen argues that the economy would be more stable if the tax code were to be reformed to avoid incentivizing companies to use debt financing rather than equity financing. Although there are certainly other frictions and inefficiencies that can cause deviation of market values from Modigliani-Miller, I think the argument is a good one.
I hereby propose that the tax deduction for corporate interest be phased out over the next 20 years.
But that would mean most can not get or establish credit to have any debt. Credit is based on risk from many factors. Its expensive to have all debt based on valuations. Once credit tightens we see the problems it brings. Government is perhaps the highest risk taker as seen time and again. They guarantee debt; no one else will.
This is why I said to phase out over 20 years rather than suddenly changing the rules. Of course a sudden change would shock the system and is a bad idea - I fully agree with you there.
It wouldn't matter. In reality corporations would no longer engage in debt financing because of the problems I put forth.
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Originally Posted by ncole1
You mean the bondholder? Sure, but dividends are already double taxed, why not put them on an equal tax footing?
I think I already explained that.
Quote:
Originally Posted by ncole1
I don't see why the fact that the payment is required matters much*, unless the corporation has so much debt that it is at a high risk of default, in which case this is precisely when we should not be encouraging debt as it already has too much!
*The exception would be if the corporation has a new, highly capital-intensive project available in the immediate future.
Because the debt is an actual expense to the corporation and the shareholders.
Quote:
Originally Posted by ncole1
I am talking about C corps here, not S corps.
Tax law applies to all corps. The C vs S election just determines the rates for the most part.
It wouldn't matter. In reality corporations would no longer engage in debt financing because of the problems I put forth.
They would still engage in *some* debt financing, just not as much as they do now. Retail outlets would probably still use vendor financing, for example, since it is not practical to use equity for that and holding a cash reserve would be unproductive during a good portion of each billing cycle.
Quote:
Originally Posted by lycos679
I think I already explained that.
Because the debt is an actual expense to the corporation and the shareholders.
This works both ways - equity is an expense to the bondholders, even though the contractual amounts the bondholders receive is fixed rather than depending on the company's profits. Think of it this way: When a company is seeking to take on debt, the company's anticipated expenses and the desired return on the shareholders' equity has an impact on how much interest bondholders can charge before the company will simply not take on the debt in the first place. Therefore, equity is an "expense" to the bondholders as it means they must charge less interest if they want to lend their money at all.
Quote:
Originally Posted by lycos679
Tax law applies to all corps. The C vs S election just determines the rates for the most part.
A C corporation has to pay corporate income taxes, while an S corporation does not. Therefore, the preferential tax treatment of debt exists only for C corps and not for S corps.
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