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Leveraging will survive U.S. corporate tax reform

Staff Writer |
Analysts from a major bank believe that reducing the top corporate income tax rate from 35% to 20% will slow the average annual increase of U.S. industrial company debt over the next 10 years from nearly 5% without a tax cut to roughly 2% with the tax cut.

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However, what happened after the slashing of the top corporate income tax rate from 1986’s 46% to 1987’s 40% and, then, to 1988’s 34% questions whether prospective tax cuts will more than halve the growth of corporate debt over the next 10 years.

Nevertheless, business borrowing is likely to be noticeably lower if business interest expense is no longer tax deductible, John Lonski, Chief Economist, Moody’s Capital Markets Research, writes.

Such tax-reform induced reductions in business borrowing will be most prominent among very low grade credits and during episodes of diminished liquidity, extraordinarily wide yield spreads for medium- and low-grade corporates, and exceptionally high benchmark borrowing costs.

The top corporate income tax rate probably will be cut from i 35% to either the 20% proposed by House Republicans or to the 15% offered by Trump’s team.

Assuming, for now, the continued tax deductibility of corporate interest expense, a lower corporate income tax rate increases the after-tax cost of corporate debt. However, a reduction by the corporate income tax rate may add enough to after-tax income to more than offset the burden of a higher after-tax cost of debt.

In addition, today’s relatively low corporate borrowing costs will mitigate the increase in the after-tax cost of debt stemming from a lowering of the corporate income tax rate.

You can read the whole analysis here.

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