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U.S. tax reform – Effect of decrease in the tax code’s bias for debt

The much awaited tax reform has at last arrived to reduce the tax code’s bias for debt. As per the recent announcements, the U.S. corporate tax rate may reduce to 25% from 35%. The non-financial corporations will be allowed a deduction of nearly 65% of their gross interest expense, whereas the financial corporations will be allowed a deduction of up to 79%. Some special rules and regulations have also been implemented for the corporations who have stated a malfunction in the tax purposes.

Interest Rates

Interest Rates (Photo credit: 401(K) 2013)

According to various financial experts, the general strategy is to reduce the corporate tax while restraining the interest rate deduction. This strategy may be helpful in reducing the tax code’s bias for debt. Consequently, the investments projects may get more lucrative for U.S. in the near future.

Debates are on regarding whether the situation will really improve or not. Doubts have been raised whether the tax code’s bias for debt will actually be modified or not. Well, there are justified reasons behind these doubts and debates. The reduction of tax code’s bias has both benefactors and oppositions. If the bias gets corrected, then it may be helpful for numerous debt finances. On the contrary, some organizations which were used to take advantage of this bias may face serious hike in the tax burden. They may encounter difficulties to pay off taxes.

However, the evaluation of the tax reform proposal must not be done by judging only individual interests. If the tax reform may help in overcoming the economic obstacles in U.S., then it should be received positively. It’s being assumed that the tax deductions may lead to efficient distribution of resources. Many corporations may avoid issuing debts because of interest rate deduction. This will ensure that the organizations will not make financial decisions due to tax purposes. Rather, the decisions will be influenced by economic reasons. This may be beneficial for an overall economic growth in U.S.

As per some financial analysts, the application of interest cap to the pre-existing debt is not an excellent idea. To make the reformation successful a few other steps must also be taken by the U.S. government. If the tax reformation permits grandfathering of accessible debts, then the corporations may rush for issuing long-maturity debts. The rush to pay off taxes must be reduced too. For the reduction of the rush the U.S. government must take some fortified step. Only then the corporate taxes may be controlled and the reformation may turn out to be really effective.

There are arguments regarding what should be the nature of tax reformation. Many financial experts believe that the interest cap must be applied only to the net interest expenses and not to the gross interest expenses. This opinion has faced much criticism. The application of interest cap to the net interest expenses may raise the amount of revenue. As per the reports of the Congressional Research Service, the reduction in the corporate taxes may reach the 15% notch.

The restriction of net interest rate deduction may even increase the effective marginal tax rates on the vital debt-financed investments. So it’s better to concentrate on applying the interest cap on net interest expenses rather than targeting gross interest expenses.

The U.S. tax reforms may have reduced the tax code’s bias for debt but it’s not yet clear how effective this is going to be. Unless the tax reforms turn out to be completely revenue-neutral, it can’t be effective enough.

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