Tuesday, May 19, 2015

Compared to The Really Great Distortion by the Basel Committee, The Economist’s Debt/Tax Distortion seems smaller.

The Economist makes some good points about the distortion produced by the tax deductibility of borrowing costs, “The great distortion” May 16.

Indeed but compared with the distortions produced in the allocation of bank credit by the credit-risk-weighted requirements for banks, those distortions seem minor. The distortion The Economist refers to, favors debt over equity, and produces a suboptimal debt/equity mix. The distortion current bank regulations cause affects the access to debt. Those perceived as safe, and who therefore already have better access to bank credit, will have even more so. And those perceived as risky, and who therefore already have difficulties accessing bank credit will have even less so. And that, which kills opportunities, is a real potent inequality driver.

The Economist writes: “Corporate financial decisions are motivated by maximizing the relief on debt instead of the needs of the underlying business.” But in the same vein, minimizing equity is now more important for banks maximizing the risk-adjusted returns on equity, than looking out for worthy borrowers.

In the briefing “Ending the debt addiction”, “the implicit government guarantee that props up big banks” is identified as a distortion. But that implicit guarantee is made much larger, and regressive, by the fact that it can be leveraged much more when lending to the safe than when lending to the risky.

I am glad to see The Economist could favor “to abolish corporate tax entirely- and instead have one layer of tax levied on the income individuals receive from investments in firms. That is indeed something that I have often proposed, like in “My tax paradise

Where I differ strongly with The Economist though, is when it refers to the lower tax revenues government receives because of the deductibility of interest on debts as “a cost in forfeited tax revenues”. Refer to it only as "lower tax revenues", instead of a “cost”, it can sometimes signify a benefit… for all. Besides how much tax is paid yearly because of the higher property values?