The Hidden Entitlements

6. Mergers and acquisitions

The deductibility of corporate interest payments, even in the case of "junk bonds" and other types of debt that are more like stocks than real borrowing, helped fuel a wave of leveraged buyouts and other debt-for-stock transactions in the 1980s. From 1985 to 1990, more than $1 trillion in new corporate indebtedness was incurred, accompanied by $54 billion in corporate stock retirements--a combination that costs the federal Treasury some $20-30 billion a year in lost corporate taxes. The deals that were struck then cannot be undone, but strict curbs on interest deductions on debt used to finance acquisitions and other limitations on companies' ability to characterize equity as debt could help keep this problem from resurfacing and making the revenue hemorrhage even worse. In particular, interest on debt incurred to purchase stock (perhaps in excess of, say, $5 million) could be made nondeductible, thereby curbing a perverse tax incentive for corporate debt.

In addition, many companies that made acquisitions in the eighties took extremely aggressive positions on their tax returns in an attempt to writeoff what they paid for "goodwill" and similar "intangible"assets (like brand names) that generally don't decline in value over time.Unfortunately, the 1993 budget act essentially ratified this practice, which may encourage future acquisitions. Repealing that 1993 change and clarifying the law to make crystal clear that no goodwill write-offs are allowed would remove a significant bias in the tax law in favor of economically unwarranted mergers and acquisitions.

Tax subsidies for mergers and acquisitions are not included in the official tax expenditure budget, but they do impose significant costs on the Treasury and the economy.


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