Private equity executives have long advocated for tax reform so that our code is simpler, fairer and creates a pro-growth environment which allows businesses to realise their full potential.
The good news is that Washington is focused on reform and close to achieving the most meaningful tax code rewrite in over three decades. As is common with comprehensive policy changes of any nature, the first proposals for tax reform include bad policy alongside the good – in this case, an undue and harmful limitation to full interest deductibility as part of larger reform measures.
This particular proposal runs counter to the objective of economic growth, and there is widespread concern among GPs and LPs alike that such a change will fundamentally disrupt the private equity business model.
Within our industry, full interest deductibility is critical to business operations at the portfolio company level. Private equity firms invest in portfolio companies and appropriately use debt to improve a company’s financial health, reshape operations, and grow or turn around a business. Full interest deductibility is paramount to private equity’s ability to manage this process and in turn, provides top-notch returns to pensions, university endowments, charitable foundations and other LPs.
Private equity is not the only industry which relies on the ability to deduct interest on debt. This tax provision has fostered significant growth in agriculture, small businesses, construction, utilities, healthcare, telecommunications and real estate, among others. In this sense, our industry is far from alone in its concern that changes to the deduction will result in long-term damage to our economy.
From a broad perspective, interest deductibility has helped countless business leaders across nearly every industry invest and grow their companies. As a normal cost of doing business, the ability to deduct interest on debt has existed since the creation of the modern tax code in the early 20th century. For companies of all sizes, access to affordable credit and capital markets is critical to invest in new technology, expand operations, and create jobs.
Regardless of other pro-growth proposals, such as lowering the corporate tax rate, a change to full interest deductibility would have a crippling effect. It amounts to both the introduction of a new business tax and an increase in the cost of capital. For private equity, it would constrict portfolio companies in a downturn; the time in which the deduction is needed the most.
Early proposals in Washington have differed in their approach to a potential change to the treatment of interest deductibility. The House Ways and Means Committee suggested earlier this year that a direct trade-off from interest deductibility to 100 percent expensing might be a suitable policy change. More recently the Administration proposed a limitation to interest deductibility with an additional window for expensing.
To be clear, neither a full trade-off to expensing nor any type of limitation on interest deductibility would help achieve the goal of pro-growth tax reform. Again, such proposals would do more than singularly harm the private equity industry; negative ramifications would occur across industries and business types.
The message to lawmakers is simple: do not harm a long-standing, proven catalyst for business success. There are plenty of current policies that should be changed or removed from our tax code, but the best approach for interest deductibility is to leave it in place.
Mike Sommers is president and chief executive of the American Investment Council. His commentary appears in response to Private Equity International‘s editorial ‘Why changing interest deductibility could turn PE ‘upside down’, published on 12 October.