Capping the Deductibility of Corporate Interest Expense
18 Pages Posted: 19 Dec 2012
Date Written: 2012
Robert C. Pozen is a senior fellow at the Brookings Institution and a senior lecturer at Harvard Business School. Lucas W. Goodman is a research assistant for Pozen. The authors are grateful to Alan Auerbach, Ted Buerger, Marc Goldwein, Don Marron, Jim Poterba, Richard Skillman, Alvin Warren, and Matthew Weinzierl for their helpful comments on previous drafts.
Many lawmakers have indicated support for reducing the statutory corporate tax rate from 35 to 25 percent on a revenue-neutral basis. However, they have not made clear how they would broaden the base enough to pay for that rate reduction. This report proposes a specific approach for revenue neutral corporate tax reform: limiting the tax deductibility of interest expense for C corporations. That would significantly reduce the tax code’s bias in favor of debt-financed investment relative to equity-financed investment, while keeping the overall cost of capital roughly the same.
The authors propose reform that lowers the corporate tax rate from 35 to 25 percent and allows nonfinancial C corporations to deduct only 65 percent of their interest expense, with special treatment for the financial sector and for companies that would have otherwise realized taxable losses. Based on a static analysis of aggregate data between 2000 and 2009, the authors calculate that the revenue loss from lowering the corporate tax rate to 25 percent would have been about the same as the revenue gain from their proposed limits on interest deductions.
Keywords: corporate tax reform, debt bias, interest deductions
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