Thursday, November 11, 2021
David Hasen (Florida; Google Scholar) presents Interest Deductibility Under the Income Tax at Indiana today as part of its Tax Policy Colloquium hosted by Leandra Lederman:
The proper tax treatment of interest expense has been a subject of disagreement since the inception of the modern income tax in the early twentieth century. On one view, the purpose of the financing transaction dictates the tax treatment, so that interest paid on borrowing used to finance consumption should be nondeductible, whereas business interest should be deductible. On another view, interest paid does not constitute a consumption item but rather a mere shift in resources and therefore should be deductible at all events, assuming the recipient includes in income the interest received.
Both of these views lead to conundrums that cannot be resolved without considering the broader question of why some expenses are deductible at all.
Focusing on that question, it turns out that business interest, like any other business expense, should generally be deductible as a timing or an accounting principle under an income tax. That principle does not apply to personal interest expense. Nevertheless, there may be an independent basis to permit a deduction for personal interest expense that is grounded in considerations of vertical equity.
A related question arises in the business setting when loan proceeds finance the purchase of business assets that are taxed under consumption tax norms. Congress has lately sought to limit interest deductibility in this setting, but a better approach would be to apply consumption tax norms more consistently to the overall arrangement. Under consumption tax norms, business interest remains deductible but loan proceeds are includible in gross income.