Efforts to achieve comprehensive tax reform are under way and action is expected this fall. Sen. Max Baucus, D-Mont., and Rep. Dave Camp, R-Mich., are spearheading this effort and kicked off this initiative over the summer with the “Tax Reform Roadshow” in several cities. They are taking a blank slate approach to gain input from various stakeholders on possible policies to reform the tax system.
While a formal proposal for comprehensive reform has yet to be finalized, legislation is going forward on several one-off reform ideas. These are not necessarily tied to a comprehensive package that would reduce tax rates by eliminating various deductions or credits. One notable example is a fundamental component of the Tax Code: the ability of companies to account for interest expense as a cost of doing business.
Since the U.S. tax code’s inception in 1909, businesses have been able to characterize interest on debt as an operating expense. Businesses of all sizes and types incur debt in the process of growth, for inventory, equipment, acquisitions, expansion and many other purposes. Among startups and small businesses—the sources of two out of every three new jobs in America—75 percent and 80 percent use debt financing, respectively.
The efforts to limit interest deductibility are driven by both philosophical and political interests. Some members of Congress believe the tax code is too heavily weighted in favor of debt and should be more weighted to equity. Other members see the elimination of interest deductibility as a means to pay for tax reform. A proposal by Sens. Ron Wyden, D-Ore., and Dan Coats, R-Ind., for example, would enact a 25 percent across-the-board limit on interest expenses to allow for a 1.5 percent reduction in the overall corporate tax rate. However, the elimination of interest deductibility is not part of a comprehensive package of reforms, so there is no assurance that tax rates would actually come down if interest deductibility were reduced. In fact, Senate Majority Leader Harry Reid, D-Nev., recently stated that his goal was to increase tax revenue by $1 trillion through tax reform. Consequently, it is possible that reform may include a reduction or elimination of interest deductibility plus other changes with no decrease in overall corporate tax rates.