The “shrinking” stock market has been a major topic of conversation in financial circles the last several years, and the data are astounding: last September, CNBC.com reportedthat the number of public companies fell to the lowest levels since 1984:
Recently, prominent financial writers Morgan Housel of the Collaborative Fund, and Tadas Viskanta of Abnormal Returns have tackled this phenomenon, laying out different reasons for the dearth of new public companies as well as positing some new policies that might encourage a renaissance in public equity.
One possible solution to this issue that I have yet to see discussed more is corporate tax reform. By reform, I do not necessarily mean reducing tax rates, but rather something substantially more revolutionary: reducing or limiting the subsidies for corporate indebtedness.
There seems to be little doubt that the current environment is immensely conducive to debt financing: corporate tax rates in the US are among the highest in the developed world (though you can argue effective tax rates are much lower), and interest expenses, which can be deducted from corporate profits just as individuals can deduct their mortgage interest expense, are at multi-decade lows:
The current levels of corporate indebtedness are simply astounding: The Economist wrote in 2015 that some 80% of the stock of “global financial assets is debt or deposits.” The latest generation of high-tech firms such as Uber and Airbnb, the so-called tech “unicorns,” are borrowing huge sums instead of going public, even though it is estimated that their market values are in the tens of billions.* By eliminating the subsidies for indebtedness, either by reducing the nominal tax rate (and thereby making interest expense less ‘valuable’), or by eliminating interest deductibility altogether, corporations would likely turn more to equity issuance for their financing needs.
There would certainly be pushback by lobbyists on this prudent reform, and it is almost certain that taxes at the personal level would have to rise to offset any reduction or elimination of the corporate tax. But overall the economy and the system that finances it would be stronger. As The Economist put it, “In times of crisis, equity bends, but debt breaks.” That is a primary reason, that same article noted, that collateral damage from the tech bubble crash, which was actually twice as large as the financial crisis in terms of asset value decline, coincided with only a mild recession instead of a major economic downturn. The near-term costs of any major reform would be large, but, in the very long run, we would all be better served by a more prudent capital structure.
*It is true, as a reader pointed out, that many unicorns are currently unprofitable, so ending debt subsidies may not make an immediate change in their financing operations. However, presumably they will not remain profitless forever, so my argument on the side of reform still stands.
