Tax leverage: debt and equity

In July we ran some blogs about the tax treatment of debt, which has played a major role in the latest financial and economic crisis. We quoted Prem Sikka as saying:

"Let us cut the welfare programme enjoyed by corporations – for example, the tax relief on borrowings. This would also help to address excessive leverage, one of the causes of the banking crisis as well."

Now John Plender is on the case, in the Financial Times.

"Policymakers should, in turn, think about the tax treatment of debt. It beggars belief, after such a monumental debt binge, that this fundamental spur to leverage scarcely features on the policy agenda. . . . Eliminating the tax relief on corporate debt is the obvious solution to reducing the corporate addiction to debt, but no one advocates it."

This is a colossal issue, and it is well worth reading Sikka's article again, alongside Richard Murphy's article published around the same time, which noted that:

"Private equity exploits this (tax deductibility of debt interest) to the full. They load their UK companies with debt and pay the interest offshore where it is not taxed on receipt. In effect for every £1 of interest paid a 28p tax subsidy is given by the UK taxpayer – an extraordinary mechanism for shifting wealth from the poorest to best off in our society."

And the results? Back to John Plender in the FT:

"Remember balance sheet efficiency? This was one of the countless virtues, much trumpeted in business schools, that private equity was supposed to bring to the quoted corporate sector. It turned out to be largely claptrap, as the debris from numerous leveraged buy-outs bears witness. The academics were doing a splendid job in softening up business on private equity’s behalf, but performing a singular disservice to the wider community in peddling their intellectually toxic wares."

This is all part of the necessary sea change in mainstream ideologies that are, thankfully, at least starting to shift back towards more balanced perspectives. But we still have a very, very long way to go.

Update: this new academic paper from the Max Planck Institute - which this blogger can't access - looks interesting.