Open AccessTax Code Revision and The Value of Tax-Deductible Debt
Author(s) -
William C. Randolph
Publication year - 1970
Publication title -
journal of business strategies
Language(s) - English
Resource type - Journals
eISSN - 2162-6901
pISSN - 0887-2058
DOI - 10.54155/jbs.14.1.19-31
Subject(s) - tax shield , economics , deductible , value added tax , tax credit , valuation (finance) , microeconomics , tax reform , corporate tax , capital structure , monetary economics , leverage (statistics) , cost of capital , tax basis , deferred tax , enterprise value , debt , tax avoidance , finance , public economics , state income tax , actuarial science , profit (economics) , gross income , machine learning , computer science
This paper examines a tax policy change that would eliminate the interest expense as a tax-deductible item for businesses. We analyze this change using a tax revenue neutral setting in a Modigliani-Miller world. The analysis uses two scenarios to compare the change to the present U.S. Tax Code. Scenario one assumes a non-competitive environment with sticky prices. Scenario two assumes that companies or industries with low leverage would cut prices instead of realizing excess profits. The reduction in prices will redistribute the present value of the corporate tax shield from the stockholder to the consumer. Using the Modigliani-Miller methodology for valuation, the maximum value (equivalent to theoretical value in this case) of the tax shield is approximately $712 billion. The actual value is probably less than half the theoretical amount. Under either scenario, the weighted average cost of capital increases for levered firms.