Study: Limiting debt tax shield bad for growth

In the midst of growing momentum to implement tax reform in the US, Ernst & Young published a study critical of calls to limit the deductibility of interest on debt.

Lawmakers have been considering ways to produce a revenue neutral reduction on the US’ relatively high corporate income tax rate. Weakening the debt tax shield is being considered one way to do it. 

The interest write-off has been a key component of the private equity model, allowing dealmakers to supplement their capital firepower with tax advantageous leverage on target companies.

The E&Y report may provide optimism the debt tax shield will remain intact, concluding that capping corporate interest expenses would harm long-term economic growth by raising the cost of capital to do business. The study was commissioned by a business coalition in support of preserving the debt tax shield, named the Businesses United for Interest and Loan Deductibility (or BUILD). 

The study analyzed a 25 percent across-the-board limitation on corporate interest expenses proposed (and stalled) in Congress earlier this year, concluding that the economy’s growth would slow 0.2 percent in the long-run, or about $33.6 billion by today’s money, to achieve a modest 1.5 percent reduction in the corporate income tax rate. Moreover investment would fall 0.3 percent (or $6 billion) over a similar long-term time period defined as 10 years or possibly more, according to the study.

The study adopted a methodology used in a similar E&Y study conducted last year on behalf of the Private Equity Growth Capital Council, which commissioned its own look into tax reforms. Specifically the study looked at a company’s marginal effective tax rate (METR) to determine if the benefits of a lower corporate income tax rate would outweigh the costs of less corporate interest expenses to shield against tax.