Wednesday, October 19, 2016

What if we tax corporate interest expense?

This is the effective corporate income tax rate:

Graph #1: Effective Corporate Income Tax Rate
We looked at it recently. The graph today shows annual (not quarterly) data.

This is the money corporations paid out as interest expense:

Graph #2: The Cost of Interest to Corporations
Interest is a tax deductible business expense. What if it wasn't? If interest wasn't tax deductible, the corporations would have to pay tax on the money they spend paying interest. How much would the tax have been? To find out, we can multiply the interest cost shown on Graph #2 by the tax rate shown on Graph #1:

Graph #3: Additional Tax Paid by Corporations if Interest Was Not Deductible
For the most recent year, the tax rate is a little over 25%, the interest expense is a little over $800 billion, and the tax on that amount comes to a little over $200 billion. Assuming that everything else stays the same.

What if we take this additional tax that corporations would have paid, and see what happens to the Federal deficits when the extra revenue is added in:

Graph #4: Actual Deficit (red) and Deficit Reduced by Taxing Interest Expense (blue)
Assuming that everything else stays the same, the Federal budget goes to surplus in the 1970s. It goes to surplus in the 1980s. It goes to surplus in the 1990s. It even goes to surplus in the 2000s.

Of course, everything else would not stay the same. Corporations would borrow less. Adjustments would have to be made. Perhaps there would be fewer mergers and acquisitions. Perhaps policy would be forced to shift away from the reliance on credit.

I can't tell you specifically what would change. I can tell you, though, that there would be less debt, and less credit use. And I can tell you that our economy can function on less credit. There was far less credit in use in the 1960s, for example, than there is today. And the economy was good.


The Arthurian said...

This is not a policy recommendation. It's a "what if".

The Arthurian said...

A related post: Following up with Alvin C Warren