PEGCC Response to William Cohan’s Bloomberg Column on Issue of Interest Deductibility
The Truth about Interest Deductibility
A Response to William Cohan’s Bloomberg Column
A January 23, 2012 column authored by William Cohan (“Private Equity’s Public Subsidy Is a Tragedy”) grossly exaggerates the impact of interest deductibility on corporate debt in private equity transactions. This document provides readers with basic facts about private equity’s use of debt that counter the various assertions the author makes in his column.
Assertion: “American taxpayers subsidize the private-equity industry.”
Fact: The vast majority of American corporations finance a portion of their operations with debt. The debt of private equity-backed companies is treated no differently than the debt of any public or private company. Surely Mr. Cohan does not believe that the American taxpayer is subsidizing every U.S. company.
Assertion: “Corporate debt is the mother’s milk of a leveraged buyout, there would be no private-equity/LBO industry without this huge tax benefit.”
Fact: The average equity contribution in a private equity transaction has increased from 10% in the 1980s to nearly 40% today. That means that the private equity firm puts up $1 in equity for every $1.50 they borrow from the bank. This debt/equity ratio is on par with many public companies and is, in fact, far lower than the leverage ratios employed at investment banks, which are typically levered 10:1 or higher.
Assertion: By loading up a company with debt and then deducting the resulting interest expense, tax payments are generally wiped out…Given that tax revenue is necessary for the government to function, this means the rest of us provide a subsidy that allows the private-equity firms to thrive.
Fact: Mr. Cohan omits an important part of this equation. For every dollar of interest expense paid by a company, there is a corresponding dollar of interest income recorded by the holder(s) of the debt. Under the tax code, the debt holders are required to pay ordinary income tax rates on this income, thereby supplying the Treasury with the tax revenue that it needs to function.
Assertion: [T]he magic of the entire industry depends almost solely on the interest-expense provision in the tax code.
Fact: There is a “magic” to private equity but it has nothing to do with interest deductibility. It has everything to do with aligning the interests of owners, investors and management so that everyone can focus on a single objective: improving the company to make it a more valuable enterprise. Today, private equity firms bring operational and managerial expertise to the companies in which they invest. They make strategic investments in R&D spending, product development, operational capacity and sales and marketing.
One final point: Mr. Cohan acknowledges that “undoubtedly many companies that might have failed have been turned around” as a result of private equity investment. This is the most (and perhaps only) accurate part of his story, and it leads one to an inevitable conclusion. Every company that is saved, expanded or improved by private equity has something in common – its profits almost always increase. This means one thing for the government: more tax revenue.
