From: Omar al-Bashir on 8 Aug 2010 14:28
The only downside?
As in "cuts."
"Look at Macy's: U.S. tax code encourages companies to rack up huge
By David Cho
Washington Post Staff Writer
Sunday, August 8, 2010; G01
Macy's has become the great American department store, with 850
locations scattered across all but four states. And it has gotten
there the great American way, by running up huge debts and flirting
with default, or worse.
Like other U.S. corporations, it also has had a uniquely American
incentive for its borrowing habits: the nation's tax laws.
These rules offer extensive tax breaks to companies that borrow money
and penalize those that raise cash in safer ways, such as issuing
stock. Yet despite the recent financial crash, which exposed the
perils of excessive borrowing, the rules are likely to persist in
federal law because nearly all businesses in America would oppose
eliminating these tax deductions, lawmakers say.
U.S. companies have had a long love affair with debt, and Washington
has tacitly approved. Although the tax benefits are not the only
driver of corporate America's preference for loans -- cheap rates and
corporate strategy, as in Macy's case, are other major factors -- the
tax code often tips the scales toward using debt for deals or for
expanding a business.
Over the past generation, debt in America has exploded, becoming a way
of life in nearly every sphere of society. And the tax code has been
its handmaiden. Home buyers, towns and corporations all enjoy tax
breaks that grow as they borrow more. Indeed, federal officials have
found that the deductions for business debt are so generous that the
government is, in many cases, essentially paying companies to borrow.
The surge in borrowing has opened new markets and financial
industries. It has also at times powered economic growth -- for
instance, the boom preceding the housing bust -- and activities that
wouldn't have been possible under other conditions. Commercial
developers build projects they otherwise wouldn't. Private equity
firms are able to buy out companies with huge sums of borrowed money.
Big banks that lend out all this borrowed money have come to play an
outsize role in the economy.
Debt in itself is not harmful, financial analysts say. But they also
question whether the government should be prodding companies to borrow
and favoring businesses that heavily rely on debt.
"The tax code is interfering dramatically with the choice of how you
finance and how you deliver returns in the corporate sector," said
Douglas Holtz-Eakin, an economist who heads the American Action Forum.
"Why would you build into the tax code a permanent bailout for
corporate debt-financed investments?"
The lineage of Macy's runs back to a retailing powerhouse named
Federated Department Stores, which once wielded so much influence that
it persuaded President Franklin D. Roosevelt to extend the Christmas
shopping season by moving Thanksgiving forward a week. During the
following decades, Federated swallowed up nearly every other big name
in the business, including Marshall Field, Filene's and Macy's -- and
then took the Macy's name.
But along the way, Federated accumulated so much corporate debt that
in the early 1990s the storied retailer ended up in bankruptcy. After
it reemerged and took on billions of dollars more in debt to buy out a
major rival, the company fell into trouble again and had to
renegotiate its agreements with its lenders in 2008.
Federated was among dozens of companies in the 1980s that had a AAA
credit rating -- the highest given by credit rating agencies -- and
lost it after drowning their books in debt. Now there are only four.
"We've seen a complete transformation of corporate America," said Nick
Riccio, a former managing director at Standard & Poor's who retired
after more than 30 years of evaluating the health of companies. In the
early 1980s, chief executives "were debt averse," he said. "All of
them were aspiring to the top ratings we could give them. By the time
I left, it was a completely different picture."
A heavy debt burden can also come with severe consequences, some more
obvious than others.
It makes companies far more vulnerable to shocks -- for instance, a
severe recession. It also can be more expensive than other ways of
raising money because failing to return the loan, or even missing a
few repayments, can force a company into a costly bankruptcy.
In the wake of the financial crash, corporations, including Macy's,
have been urgently paying down debt and hoarding cash. Non-financial
companies have saved up to $1.8 trillion in cash, about one-quarter
more than when the recession began in early 2007. But without
correcting the imbalance in the tax code, according to a wide range of
tax analysts, the government will continue to encourage new cycles of
debt-fueled booms and busts.
So far, there has been no effort by the federal government to curb the
role of the tax code in inflating the economy's debt levels. A
bipartisan bill in the Senate that would do so has stalled. The
financial regulatory overhaul approved by Congress last month does not
address the matter.
Macy's executives acknowledged that the company became overly indebted
in the late 1980s. They said more recent borrowing levels have been
manageable, even after the firm's debt rose to $10 billion as part of
the mammoth acquisition of its competitor May Department Stores five
But several retailing analysts said that deal left Macy's on shaky
ground when the recession began in late 2007. After the takeover,
Macy's "had big slugs of debt the next couple of years," said Ken
Stumphauzer, an analyst at Stern Agee. "They will be able to refinance
now because credit markets have opened up . . . but it was scary for a
Debt no longer taboo
For decades, the memory of the Great Depression, with its devastating
toll of defaults and bankruptcies, made executives wary of piling up
debt anew. High credit ratings from Moody's and Standard & Poor's were
viewed as a badge of success.
That changed radically in the 1980s. The rise of the junk-bond market
offered companies the chance to borrow enormous sums of money, often
for taking over other firms, in return for paying exceptionally high
Federated Department Stores was a poster child of this era. Hailed as
one of the most stable companies in the nation in the early 1980s,
Federated was bought out by Canadian real estate magnate Robert
Campeau in 1988 for $6.6 billion. Campeau borrowed most of that money
and then put it on the company to pay it back. After the buyout, for
every dollar in cash that Federated held, it had $32 in high-interest
From Campeau's point of view, all this leverage came with a big
benefit, compliments of the federal government. Under the tax code,
the company he took over could deduct its high interest payments from
the taxes it paid on its income.
If Campeau had used the borrowed money to build, say, a new warehouse,
rather than take over an entire company, he could have won yet another
kind of tax benefit. Many firms use borrowed money to pay for
buildings and equipment and are entitled to a second tax deduction
under an accounting principle known as "accelerated depreciation." As
the value of buildings or equipment declines over time, a company can
use this depreciation to reduce its tax liability.
The combined impact of those two deductions can be tremendous,
according to the Congressional Budget Office. Together, they can free
a company from paying tax on any income produced by projects financed
with debt. But that's not all. The combined deduction can be so large
that a company may also be able to apply some of it to its other
income, reducing the overall tax bill even further.
The CBO calculated the effect and found that across corporate America
companies on average face an effective tax rate of negative 6.4
percent on investments financed with debt. That means, in essence,
that Washington is actually paying firms for borrowing money. (By
contrast, if a company raises money by issuing stock, it faces the
standard corporate tax rate of 35 percent.)
"The government is writing you a check to buy that greasy machinery,"
said Ed Kleinbard, a law professor at the University of Southern
Still, Federated's massive debt would prove costly. The rating
agencies deemed the company to be a risky investment and downgraded it
several notches, making it very expensive for the firm to borrow any
more in a crunch. Its existing loans were expensive -- some had
interest rates of 17 percent or higher -- and the retailer was
counting on spectacular sales of clothes, purses and shoes to keep
pace with the payments.
That didn't happen. In the early 1990s, the savings and loan crisis
triggered a recession, and Federated wasn't ready for it. Just 21
months after the Campeau buyout, Federated filed for the biggest
bankruptcy in retailing history. More than 5,000 employees lost their
jobs. Shareholders were wiped out.
A company that virtually no one had thought could fail had collapsed.
Calls for change
Warnings about perverse incentives for corporate borrowing have long
sounded in Washington.
"The tax at the corporate level provides a strong incentive for debt
rather than equity finance," said Congress's Joint Committee on
Taxation, adding that this increases "the possibility of financial
That statement was issued more than 20 years ago. During the 1990s,
corporate debt went on to grow by 60 percent. Then, over the next
decade, it nearly doubled. Wall Street found new ways of making it
easier to borrow while the Federal Reserve kept interest rates
exceptionally low. By the end of last year, corporate America had
nearly $11 trillion to pay off, according to the Fed.
Senior advisers to both presidential nominees in 2008 called for
change. Holtz Eakin, who was John McCain's chief economist, warned
that the tax code was "subsidizing leverage." Barack Obama adviser
Jason Furman, now an economist at the White House's National Economic
Council, similarly wrote that the debt bias "encourages corporations
to finance themselves more heavily through borrowing. This leverage in
turn increases the financial fragility of the economy, an effect we
are seeing quite dramatically today."
Sens. Judd Gregg (R-N.H.) and Ron Wyden (D-Ore.) have drafted a bill
to address how the tax code treats corporate debt. But the legislation
is stalled, caught up in a much wider dispute over the taxes Americans
After Federated emerged from bankruptcy in 1992, the company bought
Macy's -- which had also gone bankrupt after borrowing too much. The
combined retailer committed to keeping its debt levels low, winning an
upgrade from ratings agencies.
But Federated's diet from big debts lasted only so long. Facing
competition from big-box retailers, Federated decided in 2005 to pull
off one of the largest deals in retailing history by buying May
Department Stores for $11 billion, combining the biggest players in
the business. The name of the company was changed to Macy's. At the
time, company executives talked of making the red Macy's star as well
known as Target's bull's-eye or Wal-Mart's smiley face.
To complete the deal, Federated agreed to absorb $6 billion of May's
debt. While Macy's benefited from the interest deduction on those
loans, the company's executives said that was not the reason the deal
Some retailing analysts questioned whether the move would actually
brighten Macy's outlook, with one writing the company had become "a
bigger dinosaur." Wall Street, however, cheered the move, and Macy's
stock rose steadily for the next two years.
Then, another recession struck. Macy's was vulnerable to the economic
shock caused by the financial crisis.
The downturn in sales forced Macy's to acknowledge in 2008 that the
May deal was worth less than it had paid. The write-down was so large
-- totaling $5.4 billion -- that it significantly reduced the overall
value of the company below a level that was allowed by its banks.
That, in turn, forced Macy's to renegotiate the agreements it had with
Macy's Chief Financial Officer Karen Hoguet said in an interview that
the company was never in danger because it began those talks in
advance of the write-down.
"We are always conscious of the balance between debt and equity,"
Hoguet said. "Life is about balance, so you try to develop your
capital structure so you can withstand the downturn. We have not had
any issues. We've had significant amounts of cash."
Macy's has cut its debt to $8 billion -- still about double the level
before the deal for May -- and the company continues to focus on
shedding even more, executives say.
But the costs have been significant.
In 2009, executives announced that 7,000 jobs would be cut. Macy's
also saw its borrowing costs soar. And the ratings agencies again
stripped the firm of the investment-grade rating it had worked for
years to restore.
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