The Zen of Corporate Capital Structure Neutrality

It is well understood that corporate capital structure affects tax collections. Most basically, corporate interest expense is deductible. With each interest accrual, the corporate tax base shrinks. Thus, there is a broad range of circumstances in which corporate managers are encouraged by the Internal Revenue Code (the “Code”) to load their corporate capital structures with debt. But there is little support for the proposition that Conpress desires corporations to adopt such debt-laden capital structures. Indeed, much tax legislation suggests congressional displeasure with the achievable degree of corporate self- integration. On the other hand, corporate equity has its charms: shareholders are able to defer their gains essentially forever. Thus, in some circumstances the Code encourages corporate managers to load their corporate capital structures with equity. Based on the numerous provisions in the Code that depress the relative tax cost of equity, it is probably safe to conclude that Congress is more sanguine about equity than it is about debt. But periodically, Congress tempers its enthusiasm. And academicians as a group find the feature of equity deferral – the realization requirement – quite troubling.