Tuesday, August 11, 2009

Reform tax code to curb risk-taking

The headline is from a letter in the FT yesterday. It asks whether government regulation of executive pay in the financial sector will help curb risk-taking, and adds:

"The incentives for these banks and corporations to become so highly leveraged exist, not because of employees’ pay, but because of the US tax code.

The US government has essentially subsidised debt by allowing companies to deduct interest expenses on their debt."

Just as we've noted recently. Quoting Prem Sikka:

"Companies borrow for a variety of reasons. One reason is that it enables them to give higher returns to shareholders, something that also boosts executive remuneration, which is often linked to profits. A key point is that the payment of interest qualifies for tax relief. Companies can offset the interest cost against their taxable profits. With corporation tax at 28% this reduces the real cost of borrowing, ie with tax relief the £100 cost of borrowing effectively becomes £72. Not surprisingly, a debt-fuelled shadow economy consisting of hedge funds and private economy has sprung up where a small change in interest rates can magnify profits many times over.
. . .
The tax concessions to corporations have been maintained regardless of whether the debt is for buying productive assets, or speculating in markets, paying exorbitant dividends, setting up operations in tax havens, or even champagne parties for friends"


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