Always look behind the curtain to see what the wizard really wants.

by w3woody

What’s Wrong With the Buffett Rule

A corporation deducts interest payments before calculating its taxable income, and then an individual owner of corporate debt pays tax on interest payments at ordinary income rates. On the other hand, a corporation pays tax on profits after interest expense. These after-tax profits are either distributed to shareholders, who pay tax on the dividends; or they are retained, in which case the stock price rises and shareholders pay tax on capital gains.

Because interest is taxed only once and profits are taxed twice, corporations take on more debt than they would in absence of the tax distortion. The distortion is mitigated by the fact that dividends and capital gains are taxed at lower rates than interest income. Because the Buffett Rule would raise capital gains and dividend tax rates and, in many cases, lower the effective tax rate on interest, corporations would face even more incentive to overleverage themselves.

There is an irony here: one of the criticisms of Mitt Romney’s record at Bain Capital is that private equity firms put unhealthy amounts of leverage on the firms they acquire in order to exploit the favorable tax treatment of debt. The Buffett Rule would make that strategy even more attractive.

It’s almost as if the rule is being written to encourage leveraged buy-outs by a large massive holding company which has the ability to raise massive amounts of borrowed capital in order to expand it’s own holdings, at the cost of well-run and profitable corporations which otherwise are able to turn a profit by providing goods and services to people who want them at an affordable price point.

I wonder what sort of leveraged buy-out holding company would benefit from this sort of “reform”?