Converting Corporations to Partnerships through Leverage: Theoretical and Practical Impediments
Myron S. Scholes
Mark A. Wolfson
We explore the degree to which debt financing can reduce the
corporate-level tax on income in the U.S.. Although we show that debt is
capable of shielding the competitive rate of return on projects from the
corporate-level tax, debt financing cannot shield the positive net present
value portion of project returns. Since nontax factors preclude corporate
activities from being 100% debt-financed, a portion of the competitive return
to corporate activity is also subject to double taxation.
We also consider alternative mechanisms that serve to convert the
corporate tax to a personal tax (or a partnership tax). These include other
claims that give rise to tax deductible payments to the corporation such as
obligations to employees, lessors and suppliers. As we show, all of these
alternatives are limited in their ability to eliminate the corporate-level tax.
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