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Coherent Capital Structure Policy: Between Bailouts and the Interest Deduction

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The Federal Reserve’s recent, unprecedented corporate debt purchases will further reduce the cost of corporate debt relative to equity. Given the already high degree of leverage in the corporate sector, I argue that this is a dangerous policy choice. However, the best solution is not to outlaw the Fed’s crisis actions, but to reform other federal laws that create a debt bias in aggregate. I show how limiting the corporate interest deduction to those firms with a responsible debt-equity ratio would harmonize the goals of tax policy and bailout policy, establishing a coherent “capital structure policy” for the first time.

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