The US is not the only country where preference is given for debt tax and not equity. This, however, is a flawed policy. A number of governments regard interest imposed on debt as a kind of deductible expense. It follows that creditor payments are not subjected to tax whereas shareholder payments are done. This abnormal incentive scheme does not have any justification at all. What’s more it can be dangerous as well.
Defective US tax code
The tax code of the United States has a number of defects. A prominent one is encouraging the companies to finance by themselves. These are done by borrowing equity and not issuing the latter. President Donald J. Trump should make it an important priority for correcting such a bias. The GOP should also follow suit as they blend plans for the tax reform.
Enterprises which are extremely leveraged have a greater chance of failure to survive a downturn in the economy. This vulnerability turns the isolated asset bubbles. They become huge catastrophes. This is the reason the turn of the century boom in the sub-primes was much more damaging compared to the equity injected dot com boom that happened during the 1990s. The boom in the subprimes was possible only through credit financing.
A much more better approach will be treating equity and debt as same for all the companies- both non-financial and financial as well. A number of solutions have been forwarded, like taxing the returns of a company post allowing expenses of both equity and debt. There is no requirement to focus solely on profits which are accrued to the shareholders. This not only removes all bias which is witnessed to favor leverage. This will also encourage general investment. This far reaching plan could be too ambitious. Legislators could however get a few benefits by simply permitting deduction of the equity capital cost to match the interest deduction.
Trump led changes
The Trump administration is already sweating on a complete overhaul of taxes. If this is done, everything will turn out to be all right. GOP lawmakers have given the proposal to end interest expense deductibility net of the insurance income. This is a correct step. However this is not an ideal scenario as it will not affect any kind of companies that have sufficient interest income. Banks are noted for such activities as the excessive leverage problem could be particularly serious.