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U.S. TAX SYSTEM STILL ENCOURAGES BORROWING TO FINANCE BUSINESSES

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In the 1980s the American people learned the wonderful uses of debt - government, business and personal, the underlying urge in all three being the ability to buy things now, not later.

They also learned the penalties, especially as high interest rates denied them the opportunity not just to buy for the future but to finance the present and the past as well.The Gramm-Rudman Act forced government to at least attempt scaling back, and the phasing out of tax deductions on installment debt has made individuals more conscious of saving rather than spending.

But business debt is another matter. It is still encouraged, at least by the tax system.

At a time when concerns about corporate debt make news every day, U.S. tax policy continues to encourage borrowing over the old-fashioned way, which is to finance through equities, or the sale of ownership shares to the public.

Consider the ways:

- For corporations, interest payments on borrowed money is a tax-deductible expense, but payment of dividends to shareholders is not.

- Owners of common stock are taxed twice, first when corporations pay taxes on profits and again when shareholders pay taxes on dividends and capital gains. But interest on bonds is taxed only once, as income to the bondholder.

- The 1986 tax act raised the maximum capital gains tax rate to 33 percent from 20 percent, while lowering the maximum rate on ordinary income, including income from interest, to 33 percent from 50 percent.

The situation causes Wright Investors' Service, among others, to warn that changes should be considered in corporate taxation, if not specifically for the good of corporations then for the good of the entire economy.

It argues that while the high corporate debt doesn't assure a recession, "it certainly increases the risk and potential severity of the consequences, in terms of bankruptcies and job losses."

In addition, the first defense against inflation is greater productivity, which means capital investment in new techniques, new plants, new equipment. But capital investment is hardly encouraged by the tax law.

This is the direction of corporate debt:

- Non-financial corporate borrowing as a percentage of gross national product rose to 67 percent last year from 47 percent 20 years earlier, and 39 percent 30 years ago.

- In the 20 years through 1989, the ratio of interest expense to corporate earnings more than doubled to 40 percent.

- In the late 1980s, half of all funds raised by non-financial corporations came from debt issues, with the other 50 percent from equity offerings. Why debt was encouraged by the tax law in corporate matters while discouraged elsewhere in the economy is one of the mysteries of so-called tax reform.