Tax Biases to Debt Finance: Assessing the Problem, Finding Solutions

Abstract

Legal, administrative and economic considerations offer no compelling reason for the current tax advantage of debt finance in many countries. Instead, this ‘debt bias’ creates significant inequities, complexities and economic distortions. These are likely to be larger than previously thought, especially in the financial sector. To tackle debt bias, the most promising reform is to introduce an allowance for corporate equity, as some countries have successfully done. Its main obstacle is a budgetary cost, estimated at around 15 per cent of current revenue, on average for a selection of advanced economies. This cost can be reduced by granting the allowance only to new investment. The allowance could also be targeted to the financial sector and financed by special bank levies.