The sweeping US tax reform proposal unveiled by Congress on Thursday could have a dramatic impact on the bond markets and make the selling of debt less attractive for many corporations.
Provisions include clamping down on tax deductions for the interest paid on debt and ending much of the tax on foreign profits, making it easier for companies to repatriate cash.
That would likely slow down bond issuance, which in turn could put a crimp in the use of leverage and hinder growth, capital expenditure and mergers and acquisitions.
“This is going to have a very large effect on the number of quality bond offerings,” Wharton School professor Jennifer Blouin said about the cash repatriation proposal in particular.
“Why would Apple, Microsoft et cetera need to issue debt if they could tap their foreign cash? Short answer: they wouldn’t.”
Republicans in the US House of Representatives presented their outline Thursday after months of promises from US President Donald Trump to overhaul the US tax system.
Under the proposals, businesses with less than US$25m in gross receipts could still deduct interest, but most larger companies would have a cap on how much they could deduct.
Investment bank Cowen and Company said they would cap interest expense at 30% of adjusted taxable income. Companies now are generally allowed to deduct all interest expense.
“This is certainly a negative for the use of leverage, which is something that banks facilitate,” Cowen said in a report.
The House also proposes cutting the corporate tax rate to 20% and allowing companies the option to expense business costs up front, rather than amortize them over a number of years.
According to the Congressional bipartisan Joint Committee on Taxation, the provision on interest rate deductions alone would increase revenues by US$172bn.
The relatively new BUILD coalition - Business United For Interest and Loan Deductibility - has strongly opposed the proposal.
“Placing a limitation on the deduction of interest expense - a normal cost of doing business - amounts to a new tax on American job creators who borrow to invest and grow,” it said.
TROUBLE BELOW
The impact is expected to be heaviest on high-yield or so-called speculative-rated companies.
“Spec-grade companies pay relatively little in taxes, in part due to the tax shield from the interest deduction,” said Christina Padgett, a senior vice president at rating agency Moody’s.
“Leveraged buyouts and industry sectors with the highest debt-to-Ebitda leverage are among the most vulnerable,” she told IFR.
“The loss of interest deductibility is likely to remain a concern for speculative-grade companies and may outweigh the benefits of a lower corporate tax rate.”
And the road ahead will be fraught with difficulty.
“Our view continues to be that this broad reform effort will collapse under its own weight despite the use of reconciliation, which means it only needs 50 votes in the Senate,” Cowen said.
“More likely are temporary corporate and individual tax cuts that will expire after the next presidential election.”
Wharton’s Blouin underscored that the current system favors the use of debt - and that that could change under the new proposals.
“Basically, firms have two sources of external finance - debt and equity,” she said.
“The current tax system heavily incentivizes debt issuance, as interest is deductible but dividends are not,” she told IFR.
“At the margin (under the proposals), firms should be less inclined to issue corporate bonds.”