The Debt Privilege

We all know too much debt is at the root of the economic crisis. And we’ve seen lots of step-back pieces on the conditions that created the environment for that debt creation—monetary policy, of course, but also the advent of securitization, the credit-default swap, etc.

But we haven’t seen much in the news pages on another 30,000-foot-view reason: The tax code preference for debt over equity. Commentators like Felix Salmon and Steve Waldman have been talking about this for months.

As Salmon says:

We want to move away from over-reliance on debt finance, and towards a world where equity finance becomes much more common and much more boring.

Now James Surowiecki takes up the mantle in The New Yorker (emphasis mine):

The government doesn’t make people go into debt, of course. It just nudges them in that direction. Individuals are able to write off all their mortgage interest, up to a million dollars, and companies can write off all the interest on their debt, but not things like dividend payments. This gives the system what economists call a “debt bias.” It encourages people to make smaller down payments and to borrow more money than they otherwise would, and to tie up more of their wealth in housing than in other investments… Jason Furman, of the National Economic Council, has estimated that tax breaks make corporate debt as much as forty-two per cent cheaper than corporate equity.

That, obviously, incentivizes companies to lever up, which makes them more susceptible to a blowup, which scales, meaning “A debt-ridden economy is inherently more fragile and more volatile,” as Surowiecki says.

This perverse-incentives tax-code thing seems like a fertile area for reportorial inquiry, and a critical one. What I as a reader would like to know: Was it always thus, or when did it change? Can you pinpoint any correlations? How much total debt does this add to the economy that would otherwise not be there if debt and equity were treated similarly?

What would be the pluses and minuses of changing the status quo? Surowiecki mentions that Brazil and Belgium don’t privilege debt over equity, and that Germany and Denmark have recently lessened debt’s advantages. What do these experiences show us, if anything?

Salmon says when he writes about this he invariably hears, “yes, great idea, not gonna happen.” What his respondents are talking about is the impotence of opposing the debt lobby—meaning the banks, PIMCO, et al—always ripe for stories, which the press has noticed this year. Remember James Carville’s quote? “I used to think if there was reincarnation, I wanted to come back as the president or the pope or a .400 baseball hitter. But now I want to come back as the bond market. You can intimidate everybody.”

Which conjures Simon Johnson’s Atlantic piece from this spring on “The Quite Coup,” in which he writes about the financial oligarchy has re-emerged in the U.S. with “a weight not seen in the U.S. since the era of J.P. Morgan (the man).”

Such a brick wall of a lobby may make change nigh impossible, but it sure makes for good stories, as does the broader topic.

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Ryan Chittum is a former Wall Street Journal reporter, and deputy editor of The Audit, CJR's business section. If you see notable business journalism, give him a heads-up at Follow him on Twitter at @ryanchittum.