The Debt-Equity Distinction in a Second-Best World

Abstract:     
Economic and legal commentators and the Treasury Department have made various proposals to eliminate the debt-equity distinction in the tax law. The theory of the second best posits that eliminating an economic distortion does not necessarily increase efficiency if other economic distortions remain. Policymakers cannot simply assume that eliminating the distortionary debt-equity distinction will automatically increase efficiency because other distortions in the income tax will remain. This Article evaluates a number of the proposals to eliminate the debt-equity distinction, taking into account numerous distortions that are likely to remain in our tax system.

Number of Pages in PDF File: 105

Accepted Paper Series