The Hindu Business Line

Trump’s tax plan may hurt corporate bonds

If the right to deduct interest payments from income is removed, it could shrink the US bond market by a third

- CLAIRE BOSTON BLOOMBERG

Alittle-noticed element of Republican­s’ planned tax reform could slash the size of the US corporate bond market by as much as a third, according to one bank’s estimate.

President-elect Donald Trump and Congressme­n from his party have both suggested cutting corporate tax rates. To pay for those reductions, the House Republican­s plan calls for eliminatin­g a key tax benefit associated with companies’ borrowing, namely the right to deduct interest payments from income.

That tax deduction has helped the investment-grade corporate bond market grow to $4.87 trillion of debt outstandin­g. Ending that benefit could eventually slash that figure by around 30 per cent, according to Bank of America Corp. analysts that considered data from the IMF. Eliminatin­g that benefit would likely raise about $1.1 trillion of US tax over the next decade,according to the Tax Foundation, a think tank.

That would help offset another part of the House Republican­s’ tax plan: companies would be allowed to deduct their expenses from capital expenditur­e in the year in which they occurred, instead of spreading them out over a longer period of time. Allowing that change gives businesses an incentive to invest in factories and other assets, without necessaril­y encouragin­g them to favour debt over equity financing. The Tax Foundation estimates that switching to immediate deduction will result in $2.2 trillion of lost revenue.

An alternativ­e

The House plan would hurt companies that fund themselves heavily with debt, such as banks and commercial real estate firms, by increasing their tax bills and decreasing

Even if lawmakers just reduce the corporate tax rate next year, companies will have less of an incentive to borrow, because with lower tax rates, a company gets less of a benefit from using deductions, Bank of America analysts wrote in a note. That alone could lower debt issuance volume.

or investment-grade companies, eliminatin­g the deduction for interest expenses while cutting tax rates to 20 per cent, the level that the House Republican plan calls for, would boost net income by an average of about 11 per cent, according to Morgan Stanley estimates. For junk companies, which pay higher interest rates and therefore have higher deductions, the increase is just 2 per cent.

Bond underwriti­ng

For big banks, the tax change would sting in at least one other way: debt underwriti­ng would likely become a smaller business. Wall Street banks have generated some $10.3 billion in fees in a record year for US bond sales, according to data compiled by Bloomberg, a figure that stands to slide with reduced issuance.

If companies fund their business with more equity, then stock underwriti­ng businesses might see a surge.

Forecastin­g the precise impact of any tax code changes on businesses is difficult. For example, if tax rates are lower, projects and other capital expenditur­e that might previously have been unprofitab­le could become profitable, which could lead to a rise in investment, at least some of which would likely be financed with debt, according to Bank of America strategist­s.

But long term, if the tax incentive to issue bonds starts to disappear, outstandin­g debt levels will likely drop, said Hans Mikkelsen, head of high-grade credit strategy at Bank of America.

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