What Are the Arguments for Privileging Debt?

Three cheers to Jim Surowiecki for unambiguously adding his voice to those who would abolish the tax-deductibility of interest payments:

Debt didn’t get dangerously out of scale because the system was broken. It got out of scale, in part, because the system worked…

As much as possible, the tax system should be neutral between debt and equity, and between housing and other investments. It’s not, and, worse still, as we’ve seen in the past couple of years, debt magnifies risk: if companies or individuals rely on large amounts of leverage, it’s much easier for bad decisions to lead to insolvency, with significant ripple effects in the wider economy. A debt-ridden economy is inherently more fragile and more volatile.

The weird thing for me is that when I start banging this particular drum, I always get exactly the same answer: “yes, great idea, not gonna happen”. But is there any intellectual justification whatsoever for making corporate interest payments tax-deductible? I can see an argument for a carve-out for highly-regulated banks, since their entire business is based on making profits from the spread between the rate at which they lend and the rate at which they borrow. But banks aside, why should companies pay lots of tax on dividends, and no tax at all on bond coupons?

In a way it’s depressing: if this were a real debate and Paul Volcker had a remote chance of making interest taxation happen, then surely there would be no shortage of academics and corporate lobbyists making the case for keeping the status quo. The fact that they’re not even bothering is all the evidence we need that this isn’t even going to reach trial-balloon status, let alone get signed into law.

But still, the question remains: If they were to start taking this seriously, what arguments would they use? After all, as Surowiecki notes, the likes of Brazil and Belgium seem to do perfectly well without giving debt this artificial advantage.

Comments

[Moon Kil Woong:]

The government needs more taxes not less. This tax deduction will be offset by what? Higher taxpayer taxes most likely. When will we stop rewarding risk taking. In no small part tax deductions on homebuying tips the scale for many to borrow a lot and buy houses. And a fine mess that gets us into. Do we really need more of the same?

Nov 16 10:50 AM

[Davewmart:]

Re: Moon Kil Woong's comment:
Huh? The author is advocating eliminating a tax break, not creating a new one.

Nov 16 11:28 AM

[Ink:]

I think Moon was agreeing with the author and arguing that indeed the government should not even be entertaining the notion of dropping it'sd revenue intake even further. Anyway, I'll give him the benefit of the doubt.

Nov 23 10:15 AM