As lawmakers look for ways to finance a lower corporate tax rate, some are considering capping the deductibility of interest for businesses. This would be a mistake. Interest deductibility (ID) has been a staple of the modern U.S. tax code since its inception more than 100 years ago. Businesses large and small borrow to help finance expansion, meet obligations, and fund daily operations. The ability to deduct these expenses gives firms certainty in making decisions that often affect their survival and long-term success. By instituting a new tax on business investment and slowing economic growth, limiting ID would ultimately hurt hard-working Americans.
In 2013, EY conducted a BUILD-commissioned study that found that reducing ID would negatively affect output, investment, and employee compensation in all 50 states. Under then-current economic conditions, EY assumed a 25 percent “across-the-board” limitation on ID for all businesses to be used to pay for a cut to the corporate income tax rate. EY found that in the long-run total U.S. output would fall by an estimated $33.6 billion, with between two-thirds to three-quarters of those losses coming in the first ten years. In addition, the cap would result in a $6 billion decline in business investment and a $4.7 billion drop in employee compensation. Perhaps worst of all, EY found that the 25 percent limitation on ID would only pay for a 1.2 percent cut to corporate income taxes.
Restricting the interest deduction would effectively raise taxes on American business investment. According to the EY report, the marginal effective tax rate (METR), a measure of the additional economic profit needed to cover taxes over an investment’s life, would increase substantially. Specifically, EY’s study shows that the METR would increase by 9.6 percent in the corporate sector and 6.2 percent in the business sector as a whole. By increasing the METR, lawmakers would be undermining their intended goal of cutting taxes on business investment.
Many states stand to lose from greater ID restrictions. Citing the EY study in an op-ed published by Insider Advantage, Georgia State Representative Katie Dempsey argues that cutting ID by 25 percent would “curtail economic activity in Georgia by almost $1 billion.” She notes that vital sectors like manufacturing and construction, which employee hundreds of thousands of Georgians, would be particularly hard hit.
The ability of companies to fully deduct their interest expenses should continue without limitation. Efforts to curb ID run counter to the stated goals of tax reform. As Congress seeks to stimulate economic growth, boost wages, and spur business investment, the last thing they should do is curtail the ability of American businesses to access capital. Proposals to limit ID would introduce a new tax on American business investment and hurt long-term economic growth. As the tax reform debate continues, let’s make sure that preserving time-tested and effective public policy, like ID, is a priority.