Mitt Romney's background

Another aspect that hasn't been brought up here is that equity holders ought to be wary of corporate debt, if only because bondholders hold a higher preference in bankruptcy/dissolution. And generally speaking, in large publicly-held corporations, only the bondholders can 'foreclose' on the entire business to maximize their own recovery. Shareholders meanwhile almost always must either sell out or ride the train to its eventual destination. Sure equity can theoretically kick out the directors, but how often does that happen--even when merited?

Shareholders can see their value diluted by either equity issuance or debt issuance--the only thing that matters is whether there is a positive return on the proceeds as put to work by management. If the return is negative, one might have wished that equity was issued because a low stock price doesn't force the company to liquidate or seek protection--whereas an excessive debt load can. The mismatching of credit with business cycles is a very clear and present problem--one that is nowhere near as severe if you substitute equity for debt.

Then you have the problem of shifting profits from the target company to its creditors, and the additional opportunties for tax avoidance that come with it. Equalizing the treatment of dividends and interest should be a priority from a tax fairness standpoint.

Finally it's been pointed out that bondholders' preferences can leave a lot of unpaid social costs. Perhaps a change in the bankruptcy code to put employee pensions (along with state/local taxes and utilities) at the top of the list might result in less of the public (meaning, the 'innocent' public) paying the cost of private debts.

P.S. Yes I'm a credit curmudgeon raised by Silent Generation types, but still the law of 'no free lunches' applies without bias.

..so, by extension, hiring workers and paying wages that are also tax-deductible encourages companies to hire too many employees and be inefficient?

Shareholder capitalism may be better than stakeholder capitalism, but the problem we have now is that we have gone to shareholder government instead of stakeholder government. Entitlement is such a dirty word, but citizenship should entitle you to some consideration of your interests by the rest of the nation. The disconnect between the economic long run and the human lifecycle can be disregarded in theory, but disregarding it in practice results in a great deal of suffering.

"... heavy debt load can make companies more vulnerable to bankruptcy. And the extra revenues generated rely heavily on the fact that while profits are taxed, interest payments on debt are not. Critics say that in effect, taxpayers are subsidising private equity's extraction of value"
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"Critics", whoever they are (no one is quoted), are always twisting the meaning of things. For example:

1) Of course, heavy debt makes companies more vulnerable to bankruptcy. So, why PE firms do it? Are they evil? Or idiots who want to sink their own investment? Well, they do it because sometimes it is the only way to free minority shareholders held hostage and wrestle control away lenient management and unions. Think of it was chemotherapy - the purpose is to save the patient, not to poison him.

2) Also true that interest payments are not taxed, but so what? Neither are material costs or salaries (not income taxes, which is your meaning). The reason is that they are costs or expenses. Taxpayers are not affected either way; the Government is. However, fear not for the Government: interest payments from someone are necesarily interest income for someone else (lenders), who WILL, inevitably, pay taxes. The glutton leviathan will gets its piece of action. Your critics should study some accounting.

The rest of your article has a number of other biased commentaries, but I think I've made my point.

Private equity deserves the abuse that it gets because of its obsessive secrecy and refusal to explain itself in anything other than kindergarten terms.

Firstly you cannot add value to a company by adding debt to its balance sheet. Ever. So why does private equity do this? Firstly private equity does not always do this. The venture capital firms that feature in most histories of the dot com era don't add leverage because the companies they finance can't afford it and they can get an acceptable rate of return without it.

Leveraged buy-out firms that are willing to invest a $1 billion plus in a single investment (such as Bain) often do for the following reason. Private equity funds promise a return on investment of 20% p.a. compounded. To get this kind of return in essence requires their investment to double in value every four years.

Say you invest $1 billion buying a company. If you use only share capital that means that your to get an acceptable return your billion dollar company must, in four years, become a two billion dollar company.

If instead you invested $250 million of your own funds and borrowed the remainder, to get the ROI you promised your investors, you only need to turn your $1 billion company into one worth $1.250 billion in four years. Not easy but not impossible either.

Turning to the accusation of private equity being "asset strippers" they acquired this in the 1970s when private equity group would buy conglomerate companies whose parts were worth more separately than they were under the common umbrella. The classic "Barbarians at the gate" case of RJR-Nabisco was an example of an inefficient conglomerate being run essentially for the sake of its management. Private equity did a lot of good breaking these companies up and forcing the conglomerates than remain such as GE and Berkshire Hathaway)to justify their existence.

I suppose that private equity doesn't treat the public as grown ups because of unjustifiable concessions such as treating "carried interest" (the share of profits paid to senior managers of PE firms as a bonus) as tax advantaged capital gains rather than ordinary income. I suppose that an ignorant public serves the purposes of keeping lurks like this secret. Seems not to have worked though.

Retraining has a terrible ROI. What are you going to retrain a horse breeder as? Just give them a severance package or unemployment insurance or some similar cash compensation that they pay for while they were working.

Sir,
congratulation, I thought this post was spot on. I happen to be a tax lawyer and my experience of LBO is indeed that it's intended to extract money from the company by other means than dividends. What usually happens is this: shareholders sell to private equity (capital gains are usually less taxed than dividends), private equity finances the purchase by loading the target companies (or group companies) with debt (and it's a lot more fun when you do it over several jurisdictions) through a debt push-down, shareholders reinvest some of their profits in the private equity. In extreme cases, I've seen companies which were actually quite profitable being sold as much as three time over a period of a few years, leaving them each time a little weaker...I'm not an economist, but I'm not sure this really is a good way to build companies that last...
Best regards,

I am fine with the likes of Bain, although sometimes they do more damage than good.

My solution is simple, let them do their thing, just tax the hell out them.

Kill the taxation of dividends at the corporate level. Let's find out whether it's arbitrage or value-creation or in what proportion it's a mix.

That Republicans haven't fought for this tax reform is one of the major reasons I don't believe their talk when they go on and on about their commitment to using taxes to improve the economy, and that's why top rates everywhere have to go down. It's hooey. They just want to make the rich richer, and that's all they've accomplished with their lower tax rates.

I'd argue that the one candidate who is addressing this question at its root is Ron Paul. It's an impossible order for the government to legislate creative destruction and whether it's done in the manner practiced by Bain or unfolds without such assistance.

What the government can do is stop subsidizing the massive and too-convenient use of debt, which as this article correctly points out is the indispensable 'goo' of vulture capitalism (not to mention a host of other long-term national diseases).

Honestly, if you wanted creative destruction, then failing companies should just do that, fail. Or turn ownership over to existing staff, who have the most intense reason to see a turn around.

As for corporate responsibility, everyone should act morally. A corporation shouldn't use slave labor or poison rivers with waste even if it's legal. Beyond that, I don't think public corporations should engage in charity unless it somehow indirectly maximizes profits. Pass the profits along and let individuals give to charity.

I think this misses the point. How about questioning Romney on the use of profits and not just the concept itself. He's elevating profits, putting them on a pedestal, without saying why they should be so. I think this is why he will have a tough time selling the profits are good narrative.

He must do a better job of selling Americans on why they should think the profit motive is a social good. I have yet to hear him do this, instead coming across as "profit for profit's sake" guy. Most people when they hear profit is good for everyone immediately think Gordon Gekko. He needs to change that image if he expects to win.

Are we trying to answer the question "Is Bain-style capitalism immoral?" Or are we trying to decide if it should be illegal? This is important, I think, because you can hardly blame companies for making money via legal means. If we think it's bad for society we should debate making it illegal, not whether companies are being moral or not. The same goes for companies utilizing tax loopholes - you can't blame them for doing what's legal and profitable.

It's bizarre, because you actually have a legitimate - a very legitimate - argument here. Capitalism works on creative destruction, not destructive destruction, and there are clear indications that Romney's version of capitalism is the latter, reaping millions without supplying any value to society in return.

But then you get into this stuff: "Because for many people, it's clear that "capitalism" as represented by post-1980s Wall Street is a different beast than capitalism as represented by 1950s Detroit."

What?

Detroit took advantage of tax policy (and continues to) in exactly the way Romney did, using protectionist measures to benefit itself and its unions at the expense of the larger public. The death traps they built in the 70s were largely a result of being immune from foreign competition with their zany safety features and engines that didn't explode for no reason. In these instances, protectionist policies contributed to actual violent human death - many, many times over.

And when you get to the shareholder/stakeholder business, you again use primitive nationalism as a defense for proscribing what companies "should" do. This worked great in a world where Europe was on its knees from the War, and everybody else was a mercantilistic communist. But as the world opened, people realized that there are fewer nationalistic boundaries that separate their interests than their governments would prefer they would believe. Many people now have more in common with their fellow shareholders in other countries than with many of their own countrymen (example: me and you).

And besides being stakeholders, many, many (most?) shareholders are also citizens who have interests in safe communities, prosperous local economies, and the rest. And the more efficiently their investments are allocated, the more they can ensure those virtues in their communities (even if it just means by increasing their communities' taxable income).

And can we finally put the comparions to Europe to bed? Europe is not America. As ever, Europe thrives off the labor of others - previously through colonialism, presently through outsourcing their military to the US Military-Industrial Behemoth and their innovation industries to Silicon Valley, Seattle, and the scores of other innovative hubs around America. The American economic juggernaut innovates for the world and protects the world, a responsibility Europe's supposedly more humane system is incapable of fulfilling.

At any rate, if you would just lop off the second half of this article, you would really have something important. The moralizing and the false (and accidentally true) equivalencies distract from an otherwise essential argument. Sullivan does it much better here:

http://feedproxy.google.com/~r/andrewsullivan/rApM/~3/rHFEiU9M6Hw/romney...

Take note.

The argument the taxpayers are subsidizing private equity because of the tax deduction of interest is hoax: The company can deduct the interest but the lender has to pay taxes in the interest income. So the tax revenue is unchanged.

Also, the lender has build his tax liability into the interest rate so the borrower is no better of for it.

There are economists out there who say it is the duty of companies and sometimes governments to provide retraining for those who lose their jobs because their jobs have been outsourced or eliminated by creative destruction. By retraining workers for the new economy, fit and young workers will then help the economy rather than be a drain on its welfare state.

This could be a taste of stakeholder capitalism added into American shareholder capitalism. Rather than just reforming the companies, private equity firms could also reform the workforce... even if that does cut into short term profits.

Thoughts anyone?

Ugh, in reference to the Micheal Lind passage, anytime a lefty uses the word "fair", I instinctively check to see that my wallet is still there.

the debate should be whether government policy, while accepting that destruction is necessary for the economy to grow, should act to alleviate the suffering of affected workers, and prepare them to take advantage of changes.

In a round-about way are you asking whether taxpayers should accept "privatize the profits and socialize the losses"?

Perhaps it is best left to the Presidential candidates to ask the American consumer this during the general election campaign.

Regards

Tyler Cowen on the tax deductibility of interest:

"And it is difficult not to treat interest like an expense of some kind. For instance de facto interest could be embedded in repurchase agreements, which for the purposes of tax law would look more like “real expenses” and thus would be tax deductible. The borrowing would still go on, but in a more awkward fashion.
Without tax deductible interest payments, there would be an excess incentive to pay cash up front for assets rather than doing a mix of borrowing and holding cash for option demand. Corporations would go bankrupt more easily and in general face higher transactions costs.

Contrary to common impression, the tax deductibility of interest payments does not give a tax advantage to borrowing, not if the return to savings is taxed. What you save by borrowing and writing off interest payments you pay back tax on your more liquid asset holdings; admittedly there are complications and wedges when lending and borrowing rates are not the same. Therefore tax-deductible interest payments makes tax law roughly neutral in intertemporal terms, with lots of qualifications tacked on to that claim, including the possibility that some corporations can avoid the taxes on liquid asset holdings altogether.

The tax deductibility of interest payments operates in a highly imperfect manner, but at its core it is a piece of what an ideal (roughly) neutral tax system would look like, not a deviation from such neutrality."