This post was originally published on Forbes Sep 13, 2015
Whatever the long-term effect of the Bush 2016 tax plan, there is one provision that may create something of a shock to both real estate and the financing of small business. In the "Backgrounder" for the Reform and Growth Plan, we read - "Generally, businesses would no longer be able to deduct interest payments." The provision is seen as a corollary to another proposal
Under the proposal, businesses could fully expense all new capital investments, an approach that seeks to remove taxes on marginal investment returns. This would simplify the tax code and significantly increase incentives to invest in new machines, equipment, buildings, and other structures.
The Tax Reform Act of 1986 has contributed to the decline of the real estate industry. The changes that have contributed to the decline of the industry include the elimination of the capital gains tax differential, the increase in the period for writing off taxes for depreciable real property, and the limitation of the deductions of passive investment losses. These changes have reduced the market value of real property, created an incentive for divesting real property, increased the difficulty of divesting real estate, and reduced the attractiveness of investing in new housing and construction.
An Oversimplified Example
But outside the public markets, taxing interest would bash a cohort of firms with low margins or that have over 75% of their balance-sheet funded by debt. In America the obvious victims are utilities, cable-TV firms and commercial real-estate firms. Many leveraged buy-outs would be in trouble. One private-equity chief warns, “You’re opening up a Pandora’s box…It would cause massive disruption and market turmoil.” Firms might rush to list their shares and issue new equity, causing the overall stockmarket to fall in the face of the extra supply of shares.
Taxing interest would hurt bits of Main Street, too. Small firms find it hard to raise equity. Farmers would find it more expensive to get loans to smooth the seasonality of their incomes. In Europe and Asia indebted holding companies are often used to control corporate empires: some of these structures would wobble.
The cap would limit the tax value of itemized deductions to two percent of a filer’s adjusted gross income. Since it is dependent on a progressive tax schedule, a filer in a lower bracket will be able to have more deductions as a share of their incomes. Low- and middle- income filers in the 10 percent tax bracket could deduct up to 20 percent of their income, while high-income filers in the top bracket could only deduct about 7 percent.
Economists set themselves too easy, too useless a task, if in tempestuous seasons they can only tell us, that when the storm is long past, the ocean is flat again