In an often unpredictable world, any discussion of change that alters fundamental business practices can (or should) raise warning flags for business owners and their advisors. That is precisely where we find ourselves as we approach significant changes in Washington, DC, this fall, with campaign promises likely to include meaningful corporate tax reform.
A full elimination of the corporate interest tax (CIT) deduction with no offsetting benefits has the potential to result in trillions of dollars of value destruction for middle market companies – the very heart of American business. And yes, that is trillions with a “T”.
When you look at basic equation of value, you see that corporate value is a function of three factors: 1) cash flow, 2) risk and 3) growth.
Value = Cash Flow ÷ (cost of capital – growth rate)
The corporate interest tax deduction impacts corporate valuation beyond the amount of taxes paid, by increasing the cost of capital and decreasing growth. So there is a very real risk that a collection of corporate tax reform measures are both “revenue neutral” but still very destructive to wealth in the United States.
Keeping this equation in mind, you can see that tax reform that changes the corporate interest tax deduction is likely to be felt from Wall Street to Main Street, with the potential for significant implications for middle market companies and ultimately individuals at every level. An elimination of the CIT deduction could drastically reduce the functionality of this system when companies loose value and have greater constraints on their ability to make investments in corporate growth.
I recently had the pleasure of presenting a webinar on the topic with Gretchen Perkins of Huron Capital Partners and Amber Landis from the Association for Corporate Growth. Our discussion explored the implications of eliminating the CIT deduction and the unique role it plays in corporate valuation. A recording of the webinar can be found at www.acg.org/global/webinars.aspx.