In passing the Tax Reform Act of 1986, policymakers wanted to ensure that corporations would pay their fair share of tax. Congress broadened the corporate tax base, rescinded the investment tax credit, and instituted a new minimum tax. The issue of adequate tax payments has not gone away, however, because corporations have been taking larger interest deductions as a result of having substituted debt for equity on their balance sheets.
This study begins by measuring the aggregate tax consequences of corporate leverage decisions. It also examines the tax implications of recent transactions in which corporations effectively increased their leverage, not by changing their financing of new investment projects, but by reducing their outstanding net worth. The author argues that policymakers concerned with stemming further revenue losses should look to responses other than outlawing certain controversial forms of restructuring or restricting interest deductions that appear to be excessive. At most, they should consider altering tax laws to provide more neutral treatment of income from debt and equity capital.