US Tax Code Change - Interest Deductions

What I have been thinking about a lot in recent years and something that has taken a more cohesive form while watching the credit crisis unfold is how the tax system is used to subsidize the wealthy at the expense of the poor. More specifically, by giving deductions for mortgage interest the government is subsidizing the cost of owning a home to the detriment of those who don’t own a home. It is arguable that most families and individuals who don’t own homes can’t afford them thus those who can afford a home are being subsidized by those who can’t.

I believe that eliminating the mortgage interest deduction would be a bridge to far. A more tempered approach would be to allow the deduction for the original mortgage used to purchase a home but not for home equity lines, 2nd mortgages or refinancing. A cap on the maximum size of the loan should also be considered. I can already here the financial firms calling their lobbyists. This change would need to be phased in so that existing loans would be grandfathered or more families could find themselves in financial difficulty then already do. As a supported of this change I can’t wait to trot out sound bites such as, “Why should taxpayers be paying for someone’s Jet Ski”.

An even bigger change I suggest is to change the deductibility of interest payments for a corporation. If a company takes out a loan to finance expansion or normal operations the interest would be deductible as a cost of doing business. If debt is taken out to acquire a firm or to leverage up the balance sheet to distribute funds to shareholders then the interest should not be deductible. This law should be passed with generic intent language with the caveat that if a loan is questionable in its classification then it isn’t tax deductible.

Investment Banks, Hedge funds and buyout firms that are still in business have now redoubled their efforts to reach their lobbyists and probably started hiring a few more.

The benefits of this change are similar in nature to changing the mortgage deduction yet support within the electorate should be overwhelming. Why should individuals or firms be allowed to purchase companies employing hard-working Americans by loading them up with questionable levels of debt and then laying of workers to pay for it. Then as an additional slap in the face they drastically reduce their corporate taxes due to the interest on this debt. Currently the Anhueser Busch acquisition is a wonderful example although it does lack the LBO firm involvement. Various news services have speculated that part of the financial justification for the acquisition by InBev is the ability to pile debt onto the US firm and drastically reduce it’s annual tax bill to the tune of $800 million by some estimates.

Throw in a few examples of the LBO Chiefs accumulating personal wealth in the billions of dollars and state that it came out of the hide of the taxpayer and politicians wouldn’t be able to support the change fast enough.

I am sure that the impact of these changes would be widespread and that I have not considered a large number of them. In the short term it couldlead to a slow down in growth but given the current situation the impact might be fairly minimal. I would argue that much of our past growth wasn’t natural and only occurred as a result of debt juicing the system to the point where we are now so it is a cost we much bear.

I would see this change reducing the leverage of most companies providing for the cushion they require when times get tough like they are now. Many want to blame Wall Street and the Bankers for getting us into our current predicament, especially the politicians, I believe the government is largely to blame, their scapegoats simply used the system put in place by the politicians as any rational human being will try to do. If I had the ability to borrow a few billion dollars and take a firm private and then borrow even more to give myself a large dividend reducing my risk to zero I would do it in a heartbeat. I believe that option should still be available, I just don’t believe the US Taxpayer should be shouldering the cost as they do today.