Leveling the Playing Field Between Debt and Equity

Chris Farrell has a short Bloomberg Businessweek column on why we should address the debt bias in the U.S. tax system:

A 2007 Treasury Department report noted that the U. S. had the largest disparity between debt and equity effective marginal tax rates in the OECD. “The incoherence in the taxation of capital income has serious economic consequences, including the inefficient encouragement to over-invest in housing and to bear risk, as well as a misallocation of risk,” writes Joel Slemrod, economist and tax specialist at the University of Michigan’s Stephen M. Ross School of Business in a conference paper, “Lessons for Tax Policy in the Great Recession.

Towards the end of the column, Farrell makes a brief reference to one proposal that would address debt bias, a comprehensive business income tax (CBIT). In 2009, the American Institute of Certified Public Accountants (AICPA) provided a description of the CBIT as one of several tax reform options:

The comprehensive business income tax (CBIT) is a 1992 Treasury proposal for equalizing the tax treatment of debt and equity. The income of all business entities, corporate and noncorporate, would be taxed at the entity level at a flat rate of tax, but when business income is distributed as interest or dividends, it would not be taxed when received by investors or debt-holders. Capital assets would continue to be depreciated rather than expensed.

Recent cuts in the tax rates for capital gains and dividend income have reduced double taxation of corporate income and can be viewed as a move toward the CBIT approach. As outlined in the 1992 Treasury proposal, the CBIT has no individual component. Combining the CBIT with an individual tax with flat tax features would move the U.S. tax system close to a full consumption tax.

Corporate tax reform will be a key issue come next year, and one hopes that Congress will take debt bias seriously. 

Reihan Salam — Reihan Salam is executive editor of National Review and a National Review Institute policy fellow.

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