Policy Thinkers Cannot Ignore The Practical Implications Of Tax Reform Proposals For Businesses

The following is an open letter by the BUILD Coalition on behalf of its members:

The BUILD Coalition stands for Businesses United for Interest and Loan Deductibility. Our members represent industries throughout the economy, including agriculture, manufacturing, retail, and telecommunications. The coalition is committed to pro-growth tax reform. As we know from our experiences on the ground working in the American economy, achieving this goal requires the preservation of full interest deductibility (ID) for businesses.

When it comes to efforts to reform America’s tax code, our motivation to preserve ID and promote growth is rooted in our first-hand experience running the daily operations of our respective businesses. Policymakers and policy thinkers play an important role in the debate on tax reform, but businesses have practical knowledge to set the record straight on the real-world implications of certain tax proposals. While BUILD’s position is supported by economic theory and evidence, our efforts to maintain full ID are fueled by our knowledge of how the tax code impacts businesses’ ability to grow the economy.

ID is a well-established, growth-promoting component of the tax code. Interest expense is a normal cost of doing business, and by guaranteeing businesses will not be taxed on the cost of accessing capital, ID affords them peace of mind when faced with important financing decisions. Not surprisingly, a study by EY finds that limiting ID to help fund a lower corporate tax rate would negatively impact economic growth in the long-run.

Companies large and small borrow in order to help finance expansions or meet obligations, and being able to deduct the interest expense gives them the certainty to make such decisions with confidence. For many firms, access to credit is essential for working capital, and many of these companies use debt to weather shifts in demand.

Research has found that 75 percent of startups and 80 percent of small businesses rely on debt financing. Without access to affordable credit, these companies will struggle to create jobs and grow the economy.

And while some speculate that the deductibility of interest expense promotes over-leveraging by businesses, research by economists from Duke, UPenn, and Washington University in St. Louis, as well as findings by Nobel Award winning economist Merton Miller, show that the tax code has little-to-no impact on leverage ratios among companies.

Still others claim debt inherently creates risk in the economy, and steps should be taken to discourage too much corporate borrowing. However, a study published by the St. Louis Fed finds that limiting ID would actually increase volatility throughout the economy by raising the overall cost of accessing capital. Limiting or eliminating ID would push firms to intentionally cap their size and rely more on operating leverage, making them more susceptible to default.

What’s more, despite their similar function of providing access to capital, debt and equity are not interchangeable in practice. Many smaller firms lack access to equity markets altogether. In addition to the dilutive effects of equity financing, debt is also a more cost-effective financing option than equity because it offers a more secure return for investors, who charge a premium for the greater risks associated with equity.

The same goes for proposals to offer 100 percent expensing in place of ID. While well-intentioned, proposals to replace ID with full expensing would not help most business owners in practice, according to UPenn professor Chris Sanchirico. As Sanchirico notes, even proposals to lower the tax rate would “not temper” the harmful effects of the proposed trade-off between interest deductibility and expensing. At the end of the day, as businesses that make these financing decisions every day, we know first-hand that you can’t expense what you can’t afford.

Maintaining full ID is essential for achieving the stated top priority of tax reform: allowing the U.S. economy to reach its full growth potential. As the businesses that have experienced what works in the tax code and what doesn’t, we know ID works.