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Curbing Corporate Debt Bias

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Curbing Corporate Debt Bias

Do Limitations to Interest Deductibility Work? CESifo Working Paper No. 6312

CESifo Group Munich,

5 min read
5 take-aways
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What's inside?

Financial risks heighten when countries encourage debt rather than equity in corporate tax codes.

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Editorial Rating

8

Qualities

  • Comprehensive
  • Analytical
  • Innovative

Recommendation

Most nations’ corporate tax frameworks induce companies to favor debt over equity for investing and capital raising purposes. Firms can deduct interest expenses from their taxes but not equity returns. This “debt bias” unleashes enormous consequences both for corporate strategies and for systemic risk to financial markets. Policy experts Ruud de Mooij and Shafik Hebous analyze whether changes to tax regulations succeed in reducing corporate debt-to-asset ratios and in improving firms’ financial stability. getAbstract recommends this detailed and leading-edge report to executives interested in the regulatory and strategic impacts of tax deductibility and equity accounting.

Summary

Elevated levels of corporate debt pose a major threat to the global economy. During a financial crisis, companies that are highly leveraged are more likely to cut jobs and plunge into bankruptcy than are firms with lower levels of debt. Despite this risk, the corporate income tax (CIT) systems of most countries motivate firms to rely on debt rather than equity to raise capital. For example, most CIT policies permit businesses to deduct interest on their loans but do not allow them to write off returns on equity. This predilection for corporate borrowing over equity financing results...

About the Authors

Ruud de Mooij is chief of the IMF’s tax policy division, where Shafik Hebous is an economist.

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