Tuesday, November 14, 2017

Great news for liquidationists!

I was reading this terrible article with all the standard tropes about how private equity debt causes all the world's problems, and I came across this:
The Republican tax plan actually recognizes this. The House bill proposed a cap on the deductibility of interest payments over 30 percent of a company’s earnings; the Senate bill defines earnings in such a way to reduce that cap even further. This would discourage some debt-fueled buyouts, and private equity firms are screaming about it.
I didn't realize this was how the tax bill was structured.  Now, I agree that in an optimal system, we would re-engineer the tax code to stop favoring debt.  It seems clear to me that the best approach is to simply reduce corporate income taxes to minimal levels.  Because the incidence of corporate taxation is pretty diffused and because of its side effect as a highly regressive subsidy for homeowners, not only would the lower corporate tax rate reduce the incentive to debt financing, but it would also probably be a progressive change to the tax code.

I don't really know if the tax code should be any more progressive.  It seems pretty progressive already.  But, my point is, if you want a more progressive tax code, a corporate tax cut is probably a pretty good way to get there.  It's not going to be part of a CBO score, but I think if we implemented a large enough corporate tax cut, the disappearance of several tax incentives for high tier residential investment would lead to a decline in high tier prices and high tier housing expenditures.

But, why simplify things when we can make the code more complicated?  So, instead of this, Congress is talking about removing the interest expense deduction.  And, even worse, making it a function of earnings.

Of course, all of the focus of the chattering class is on private equity leveraged buyouts.  But, most firms with large debts are mature, asset-intensive firms like utilities with very stable income streams.  Investors don't like to lend to overleveraged volatile firms.  In fact, that's the reason that firms like Sears - a focus of the terrible article - leverage up, because eventually they become real estate investment trusts with a vestigial retailer attached to them.  Blaming the management for trying to manage the drawdown of that organization is like blaming the auctioneer for your foreclosure.

The other type of business that is overleveraged is a firm that is out of equilibrium - a firm that has just experienced a major shock to earnings or revenue.

And, this is what should make the liquidationists happy.  When we have a systemic contraction, which is frequently related in some way to monetary policy, there is a certain portion of the American populace, punditry, and economics profession, that cheers the dislocation.  It's seen as a way to clear out the chafe.  Let the weaklings fail.

I consider this to be the broken window fallacy applied to nominal economic growth.  There are plenty of ways for people to be harmed without us doing it on purpose in order to discipline them.

But, for liquidationists who see economic contractions as beneficial, this tax policy is ingenious.  First, a nominal shock hits the economy.  Some firms will be hurt worse than others.  Their earnings will collapse.  Usually, when that happens, one of the largest problems for the firm is paying creditors or re-issuing debt that matures in a market that is highly unfavorable.  Now, in addition to those problems, we will treat that shock as a trigger to raise their taxes!

Do you see why the liquidationists should love this?  Now, monetary and fiscal policy will be naturally aligned.  Fiscal policy will be targeting the "chafe", putting those firms out of business, while the good, profitable firms thrive with a lower tax rate.

In a general sense, I am afraid that governance has become so complicated and convoluted at every level, even if good ideas see some light of day, they get tortured and turned into terrible ideas by the time our politics are done with them.  I don't see how this improves without a revolutionary simplification.  But, there is such a shared sense of acrimony in this country.  It is obvious on the right, but really, just as obvious on the left, as the terrible article makes clear, that our citizenry and our leaders couldn't possibly be trusted to do it right.  I mean, we just had a financial crisis that basically was caused because there was a national consensus that stability would prevent other people from experiencing financial catastrophe, and imposing that catastrophe on them was just too important, even if we all had to share in the crisis in order to impose it.


  1. The US tax code…is it even comprehensible?

    Kevin Erdmann says a corporate income tax cut is progressive due to effects it would have on high-end housing markets. With 75,000 pages of tax code, and any number of economic and businesses actions and reactions to changes in the tax code, maybe Erdmann is right.

    What is going on now is not "tax reform" but more tax fiddling.

    I would triple the standard deduction and call it a day.

    I could posit tripling the standard deduction will decrease the cost of labor and thus boost corporate profits, encouraging more capital formation.

    With the US tax code, all arguments are worthy.