Letting the air out of Wall Street's balloon
PROMINENT Wall Streeters are now blaming the crash on a little-noticed tax provision approved in early October by the House Ways and Means Committee. It would limit tax deductions for interest paid on loans used to take over a company. Says Donald Drapkin, vice-chairman of Revlon Inc. and a key figure in his company's effort to take over Gillette, ``If you couldn't deduct interest incurred in an acquisition, it would be a disaster for the stock market and for American companies.'' In response to such criticisms, the committee is now backing down. Chairman Dan Rostenkowski, noting that ``some have suggested that a statement from the Ways and Means Committee may serve to calm some of the apprehensions of a very nervous Wall Street,'' says he will agree to a ``reasonable compromise'' on the provision. The Street is now breathing easier. Stocks of prospective takeover targets are already on the upswing.
My message to the chairman and to committee Democrats in particular: Don't back down. Removing tax benefits from takeovers makes eminent policy sense. It's an ideal way to discourage mindless speculation on Wall Street without at the same time deterring efficient acquisitions. And it's a golden bullet for Democrats looking for a good issue.
The rule has been that interest payments on business loans used for investment are deductible. This makes sense when the investment is in new plant, equipment, research, or anything that adds to the nation's productive wealth. But when the ``investment'' is in an asset already in use, no new productive capacity is added to the economy.
An interest deduction makes even less sense when it helps finance the purchase of an entire company. There is evidence that takeovers, and the fear of takeovers, have forced managers to prop up share prices in the short term by buying back a portion of their outstanding shares. With shares left over - presto! - the price of each remaining one is that much higher. But companies using this ploy have had to cut longer-term investments in research, employee training, and product development. They have also gone into debt - $700 billion in the last five years - which makes them exceedingly vulnerable should interest rates rise once again toward double digits, a not unlikely possibility.
Raiders and their apologists have argued that takeovers nevertheless make companies more efficient, because they force entrenched and inept managers to do a better job or leave. There's little evidence of any upsurge in productivity as a result of takeovers or takeover threats in recent years. But let us give the raiders the benefit of the doubt and assume that, at least on occasion, takeovers do have this salutary effect.
How to weigh the disadvantages of takeovers against the asserted efficiencies? One way is to remove the tax benefits, then see how many takeovers are undertaken. If takeovers are as efficient as the raiders say, then presumably takeovers would occur even absent the extra tax sweetener. If the sweetener were necessary in order to render them profitable, on the other hand, then there would seem to be little or no efficiency gain to be had in the first place.
The Ways and Means Committee's proposal would, in other words, serve as a kind of screen for sifting out takeovers that add nothing to the American economy (indeed, which are likely to undermine long-term productivity gains), while allowing takeovers that arguably promote efficiency.
Wall Street's assertion that the committee proposal was somehow responsible for the crash confirms what many of us suspected all along - that the takeover threats underlying the high share prices were motivated by the hidden tax subsidy. When it looked as if the subsidy was about to be taken away, stocks tumbled. Now that Mr. Rostenkowski is having second thoughts, takeover stocks are making a comeback. Wall Street wants to refill its balloon, until the balloon pops again.
Which brings us to the Democrats. Democrats have been talking about restoring US competitiveness. The buzzword last time around was ``industrial policy,'' which sounded too much like big-government intrusion. But America's real ``industrial policy'' lies in the countless, detailed ways in which government inevitably shapes the market - as when it determines what sorts of business expenses can be deducted from corporate income. The Reagan administration has had an elaborate industrial policy; it's just not a very good one.
Now along comes the Ways and Means Committee with a proposal to improve market efficiency, deter wasteful speculation, and simultaneously stick it to the fat cats who have been financing their finagles at the public's expense. And it would accomplish all this without setting up a new federal bureaucracy or spending the public's money. In fact, the proposal would actually reduce the budget deficit. This is ``industrial policy'' at its best.
Mr. Chairman, stop worrying about restoring Wall Street's confidence. Think instead about restoring America's economy, and the Democrats' momentum.
Robert B. Reich teaches political economy at Harvard's John F. Kennedy School of Government.