Thursday, October 27, 2011

No, sir!

Three in a row, yesterday. All pointing out the debt bias created by the tax code. Specifically, created by the corporate interest deduction. A total of four articles considered, all of them showing debt bias as a problem.

But here's something. In the noon post I quote James Surowiecki: companies can write off all the interest on their debt, but not things like dividend payments.

I complained that Surowiecki "seems to hint that maybe corporations should be able to write off both their dividend payments and their interest payments", and I rejected that option.

For this post I went back and reviewed his article, looking for more such hints, but found none. So that made me happy. It's a good article. Here's the link again.

In the four o'clock post I quoted Alvin C. Warren, who points out that "no deduction whatsoever is permitted for dividend payments." Sounds to me like another hint.

Look: Dividend payments are profit. Profit is the only part of business income that is taxed. That's bad, because it skews the playing field in favor of business spending. (And spending is the device that can generate inflation. Think about that the next time your utility company gets a price increase approved.) But it's also wrong, because the rule is that profits are taxed. You don't get to wiggle out of the rule by comparing dividends to interest costs, pretending they're the same, and coming down on the side of eliminating taxes on dividends.

That's changing the subject. The subject is corporate interest costs are not taxed, and the growth of debt that results from this and similar tax advantages. Focus on interest costs. We'll talk about dividends later.

I don't know if Alvin Warren says any more about relieving corporations of the burden of paying tax on their profits. JSTOR provides only the first page of his paper.

Also in my four o'clock I looked at Pete Davis's post. Just double-checked it now. He doesn't say anything that sounds to me like he's trying to get another tax break for corporations. He's got a good clean statement on the problems created by a tax code that allows deductions for interest costs. Here's the link again.

And that leaves Waldman. My 8 AM post.

I have trouble reading Waldman because his paragraphs are too long to fit the space between my ears. After the part that I quoted yesterday (from his first paragraph), Waldman writes, "Here's the case-in-brief." (See, I thought the case-in-brief was the part I quoted yesterday.) And then he presents us with four long paragraphs and some medium-length ones besides.

Wading through that, I get the impression Waldman is making the case *for* the corporate interest cost tax-deduction:

Creditors and equityholders are fundamentally the same...

Large-scale investment is crucial to a modern economy, and getting investors to trust strangers enough to give them their money is hard... To overcome some of the trust issues, the most nervous sort of investor, bondholders, are given the business equivalent of a doomsday device to enforce their claim on timely payments. If, of malice or misfortune, a firm fails to pay out as promised, bondholders can force a firm into bankruptcy...

Fundamentally, the right of bondholders to enforce their claims via bankruptcy is... a legal convention we've developed to encourage socially useful risk-taking that partially externalizes the downside risks for some investors.

The existence of enforceable debt financing is a very good thing. It's an essential element of the constellation of institutions by which we are able to fund large-scale capital-intensive projects without coercion.

Thankfully, Waldman also says

But... any state meddling in capital structure ought to tilt the scales towards equity rather than debt financing.

Oooh, and this I like. Well said:

When firms pay stockholders, every dollar an investor receives drops off the firm's balance sheet. But when a bondholder receives the same dollar, a US firm pays as little as 65¢. The other 35¢ is paid for by Uncle Sam, in the form of a tax deduction.

Again, that's not altogether on point, not for this post. But I can't resist including it. It's just that good.

And so we arrive at Waldman's last paragraph -- thankfully, a short one -- and the "Note" that follows it.

"So, here's my proposal," Waldman writes:

Put payments to stockholders and payments to bondholders on a level playing field. Eliminate the tax deduction for business interest payments. I'm not sure how much extra revenue this would net the Treasury, but by ending a perverse incentive for firms and eliminating a large subsidy to the wizards of debt, it would pay off hugely in the form of a more stable corporate and financial environment.

Stop after the second sentence. Here's Waldman's proposal:

Put payments to stockholders and payments to bondholders on a level playing field. Eliminate the tax deduction for business interest payments.

You might think that eliminating that deduction would bring extra revenue to the Treasury. But that's not our topic, is it. Anyway, the point here is to look at how the interest cost deduction twists and skews the natural economic forces and helps produce an economy burdened with debt, an economy whose most successful industry is finance, an economy that cannot avoid the crisis that comes when everyone suddenly realizes we have just too much debt.

I don't care about bringing extra revenue to the Treasury. Plus, it's off-topic.

The topic is not how big to make government. Nor is the topic the Federal debt and deficit, not whether those are beneficial or harmful. The topic is the corporate interest deduction and how it skews the economy.

So, Waldman says Eliminate the tax deduction for business interest payments.

And then, in the Note, Waldman says

Another way to level the playing field between debt and equity financing would be to eliminate corporate taxation entirely. I'd be cool with that too...

See? Now he's writing in favor of the corporate interest cost tax-deduction. He is willing to trade the "debt bias" for an enhanced supply side bias.

Perhaps Waldman doesn't really understand that accumulating debt is the problem. He's "cool" with accumulating debt. And rather than focusing on the debt bias, he drifts again to revenue considerations: long as it was accompanied by a tax increase elsewhere...

and then he complicates matters, raising a veil of confusion:

...whose incidence is at least as progressive as the corporate tax.

He ends his Note by skewing the reader's heart:

And really, if we are going to socialize the costs of our financial meltdown, shouldn't we socialize it disproportionately to the people who gave it to us?

If you want to understand the economy, keep your damn feelings out of it.

But anyway, I'm with Waldman on this: Eliminate the tax deduction for business interest payments.


Jazzbumpa said...

You're imposing your definition of the subject matter on Waldman, so his revenue statements look off-topic to you. They're not. He get's to define his topic.

Perhaps Waldman doesn't really understand that accumulating debt is the problem. What I understand, and I suspect Waldman does as well, is that EXCESSIVE debt is a SYMPTOM. The problems - and I suspect there is a large bundle of them - lie in policy decisions that drive debt-inducing conditions.

Encouraging personal debt is part of it.
Wealth disparity that makes basic living difficult to afford is part of it.
Lair loans, and the whole housing bubble was part of it that we will be living with for a long time.
A finance sector that makes higher profits than manufacturing - in no small part because of lax regulations on rentier activity is a large part of it.
A consumer driven economy is part of it, too - but I don't know what the hell we can do about that.

I will repeat again once more that focusing on debt is an attempt to treat the symptom. Go after the policies and conditions that make EXCESSIVE debt either necessary or attractive if you want a real solution.

I think bringing manufacturing back on shore, reinvigorating labor unions, and regulating the finance sector as it was in the early post WW II years will go a long way toward putting us back in the reasonable debt situation we had at that time.

Meanwhile, WASF

Jazzbumpa said...

My comment just got swallowed by a Blogger glitch (aka blitch.)

I'm not going to reconstruct it. I recommend reading Waldman's latest.


The Arthurian said...

I think your comment is okay. Dunno what happened.

I see debt as the problem -- or really, excessive use of credit as the problem -- because of the costs and the imbalances it creates.

I most definitely see policy as the cause of the excessive reliance on credit.

But I think I go back farther than you, nearer to the source of the problem. The fundamental concepts of policy are
1. restriction of non-credit money (as a way to fight inflation), and
2. encouragement of the use of credit (as a way to grow the economy).

Together, these two fundamental concepts relentlessly drive the growth of debt, and have done so at least since the end of the second world war.

I'm not saying that credit use was excessive right after WWII or by the early 1950s. No. But debt accumulation was already under way then, and by the 1970s financial costs were contributing to both the "stag" and the "flation" of stagflation.

The Arthurian said...

If I push "the problem" back from "debt" to its cause "policy", then I find I must push "the cause" back also, to "human nature". At that point, there is no solution. This is why I stop chasing the problem backwards at "debt".