How Reducing the Corporate Interest Tax Deduction Can Impact Middle Market Equity

However things play out in the 2017 election, a new study says that even small changes in the corporate interest tax deduction could have big implications for middle market firms.

The results of the study “Eliminating the CIT Deduction: Value Implications for Middle Market Enterprises,” were released at a meeting of the Association for Corporate Growth in New Orleans, La., in mid-May. Authors of the study said that eliminating the corporate interest tax deduction could create “significant risks” for middle-market companies by reducing the attractiveness of borrowing and the ability to grow. The report found it would lead to an average decline in equity value by 6.3% for those companies, equating to a loss of more than $1 trillion in equity for the entire middle market.

Researchers found the impacts were most notable for those companies in consumer discretionary, energy, healthcare, materials, and telecommunications services. It was less of a concern for companies operating in consumer staples, industrials and information technology. The report stated that while RGL recognizes few tax reform plans would call for a complete elimination of the CIT deduction, the data shows the “uniquely influential aspect the CIT deduction plays in corporate valuation.”

A decrease in the CIT deduction would reduce the propensity for middle market companies to borrow, which would mean higher costs of capital with fewer growth projects. Summary statistics in the report illustrated a decline in the debt-to-capital ratio by as much as 10% and a .5% reduction in the growth rate. This reduction in growth rate alone would equate to a 15% decrease in values for middle market enterprises, wiping out nearly $2.5 trillion in equity.

“While it is unlikely we can fully predict all of the ways that eliminating the CIT deduction would affect companies, its central role in valuations and capital spending decisions warranted the analysis,” said RGL Forensics partner Matthew Morris.

BUILD (Businesses United for Interest and Loan Deductibility) Coalition, an organization that aims to preserve 100% interest deductibility for businesses, has been expressing concern since 2015 about presidential candidates on both sides of the aisle calling for reductions in CIT. “While we are encouraged that Presidential candidates want to reform the tax code, maintaining full interest deductibility, a normal cost of doing business, is imperative to ensuring these reforms will be successful,” said spokeswoman Sabrina Siddiqui in a blog post.