WASHINGTON — An across-the-board cut in the corporate tax rate, as proposed by the White House Wednesday, has obvious cost benefits to many banking companies. But the industry could take a hit from other aspects of the plan, including fewer tax deductions on business loan payments.
The administration's 25-page "Framework for Business Tax Reform" calls for lowering the tax rate to 28%, from 35%. But in order to help replace lost federal revenue, the plan would also reduce or do away with various tax loopholes that companies now enjoy. Those include incentives that encourage companies to finance their operations with debt.
"A tax system that is more neutral towards debt and equity will reduce incentives to over-leverage and produce more stable business finances, especially in times of economic stress," the report states.
While the proposed changes to the tax structure are a long way from enactment, industry observers said bankers should still take note. A worst-case scenario is if corporations can deduct less interest, they may give more consideration to raising new capital and become less likely to seek to take out a loan in the first place.
"Banks like debt financing. That's their business," said Paul Merski, chief economist of the Independent Community Bankers of America. "So it should be a wakeup call for the financial sector."
William Chip, a partner at Covington & Burling, noted that not only do banks rely on lending to other businesses, but there is also another downside of the plan for banks. As some of the most heavily leveraged businesses in the United States, banks could see their own tax deductions shrink.
"It's sort of a double whammy for the banks," Chip said.
Because the Obama administration's new report only deals with corporate taxes, it does not address how the tax code favors individuals who borrow. The best-known example of a non-corporate tax incentive is the mortgage interest deduction, which frequently comes up in discussions about tax reform but still enjoys broad political support.
With tax reform expected to be on the congressional agenda in the lame-duck session after the November presidential elections, the administration's report so far is drawing mixed responses on Capitol Hill.
Rep. Dave Camp, the Republican chairman of the House Ways and Means Committee, praised of the idea of lowering the corporate tax rate and closing loopholes, but said the Obama plan should have also addressed taxes on individuals.
"If we want to truly reinvigorate our economy and get Americans working again, we must address comprehensive tax reform," Camp said in a press release. "So, while this is a good step by the Administration, I will borrow from the President's own words to Congress from just yesterday: Don't stop here. Keep going."
The idea of reducing the tax advantage that debt financing has over equity financing is not a new one. Last July, the congressional Joint Committee on Taxation held a hearing on the issue, where both Republicans and Democrats expressed openness to the idea of moving toward more equal tax treatment for debt and equity.
Glenn Hubbard, an economic advisor to Republican presidential candidate Mitt Romney, has also recently suggested that the tax treatment of debt and equity should be equalized. (Romney released his own tax reform plan on Wednesday, in which he proposed cutting the corporate tax rate to 25%.)
In the report released Wednesday, the Obama administration highlighted the issue in a chart showing the effective marginal tax rate for debt financing compared with that for higher equity, both in the United States and abroad. The effective marginal U.S. tax rate for equity-financed corporate investments is 37%, roughly in line with other industrialized countries, the report said. But the effective marginal U.S. tax rate for debt-financing, far lower than in other nations.
"There is certainly an obviously favorable impact to debt financing," said Philip West, chair of the tax practice at Steptoe & Johnson LLP.