“Private-equity firms are adding debt to the companies they own in order to fund payouts to themselves, a controversial practice now reaching a record pace,” according to the Wall Street Journal. And taxpayers are subsidizing it.
Under the controversial practice, called a “dividend recapitalization,” a company that a private-equity firm has acquired borrows large sums and then passes the borrowed cash straight to the investors in the private-equity firm as a special dividend.
It’s hard to argue that this does anything for jobs and the economy other than create a big cash payout for the private-equity firm. As the WSJ article notes, critics charge that such capitalizations instead “saddle a company with debt, potentially burdening its operations.”
And yet taxpayers subsidize the practice, since the acquired company can deduct the interest payments it makes on its borrowing.
Taxpayers should not subsidize these sorts of transactions, which one analyst says are “very reminiscent of the bubble era” that led up to the recent financial crisis. Indeed, as the financial crisis showed, encouraging corporations to rely excessively on debt poses risks for them and the broader economy.
That’s why our Six Tests for Corporate Tax Reform says that reform should reduce the corporate tax code’s bias to debt financing. Examining the tax subsidies for dividend recapitalizations, and leveraged buyouts generally, would be a good place to start.