profits plus interest payments (Table 12.2, row 6) must generate the same amount of revenue as the corporate income tax (Table 12.2, row 1). Estimates of the average tax rate applicable to the larger tax base that would have resulted in the same revenue collection range from a low of 8.92 percent in 1982 to a high of 14.64 percent in 1980 (Table 12.2, row 7).
In order to estimate the highest marginal tax rate and to preserve the progressivity of the corporate tax rate, the average tax rate on combined profits and interest payments is multiplied by the ratio of the maximum corporate tax rate (Table 12.2, row 4) to the average corporate tax rate (Table 12.2, row 5). 1 The maximum tax rates applicable to corporate profits and interest payment range from a high of 18.6 percent in 1980 to a low of 11.2 in 1982 (Table 12.2, row 8). The calculation suggests that a tax rate of 15 percent will, on a static revenue basis, generate slightly higher revenue than the current structure.
The new tax will be neutral with respect to financing choice (i.e., debt versus equity). Therefore, when considering new investment projects, corporate America will now focus on the merits of the project and not on the relative tax consequences. Choice of financing, debt versus equity, will now be irrelevant and will not determine the investment decision.
The proposal we are forwarding in this paper is literally a second-best solution and does entail the elimination of interest expense deductibility. In this case, the old adage that the best should never be the enemy of the good holds. Our proposal is not the optimum optimorum, but it is a lot better than what is being practiced today. Given the fiscal politics of Washington, D.C., our proposal may just be attainable.