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What if interest expenses were no longer tax-deductible?

ONE reason why the American equity market has rallied since the election of Donald Trump is the hope that taxes on corporate profits will be cut. But that measure has to be paid for, and analysts are only just starting to figure out where the burden might fall.

The initial focus has been on the idea of border-adjustment taxes. But another way of raising revenue is to remove companies’ right to deduct their interest expenses from their taxable income. That proviso has been in place since 1918, when it was introduced to help firms struggling with the impact of the first world war—evidence that tax breaks, once granted, are hard to remove.

Allowing interest payments, but not dividends, to be deducted from corporate profits before tax is paid is a huge distortion to the system. It is a perk worth around 11% of the value of corporate assets. It has tended to encourage companies to take on more debt. By doing so, it may make the economy more risky at the margin: in a recession, highly-indebted companies are likely to go bust more quickly, whereas companies with lots of equity capital can ride out the storm. As a result, this…Continue reading

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