The (Partial) Effects Of Tax Reform

With the U.S. corporate tax rate being among the highest among developed economies, there is discussion of corporate tax reform that would reduce the corporate tax rate from 35 percent to 20 percent, as well as the possibility of eliminating the deduction of interest expense entirely. So how would this affect corporate finance? A cut in the corporate tax rate on interest would reduce the attractiveness of debt as a form of financing, thereby reducing the amount of debt in the optimal corporate capital structure. One estimate is that the U.S. average debt-to-EBITDA ratio would drop from 4.1 to about 3 times, which would also affect the other financial leverage ratios. And the non-deductibility of interest expense would affect the calculation of the weighted average cost of capital. And, finally, at least for now, the decline in corporate debt will likely increase the credit rating for the remaining debt, driving the yield down on debt that does remain. All in all, major changes to U.S. based corporations.