Coherent Capital Structure Policy: Between Bailouts and the Interest Deduction

Abstract

The Federal Reserve’s recent, unprecedented corporate debt purchases will further reduce the cost of corporate debt relative to equity. Given the already high degree of leverage in the corporate sector, I argue that this is a dangerous policy choice. However, the best solution is not to outlaw the Fed’s crisis actions, but to reform other federal laws that create a debt bias in aggregate. I show how limiting the corporate interest deduction to those firms with a responsible debt-equity ratio would harmonize the goals of tax policy and bailout policy, establishing a coherent “capital structure policy” for the first time.