Monday, September 15, 2008

On Debt

What good is debt?  How does debt benefit me?  How does someone else's debt benefit me?  Should interest not be tax deductible?  Should mortgage interest not be tax deductible?

Debt allows one to convert income into assets and assets into income.  This makes it a very useful financial tool in many ways.  It allows the acquisition of assets without having to pay for them up front.  It unlocks wealth that is otherwise trapped in assets.  It allows consumption smoothing over time.  It can transfer inflation risk from borrowers to lenders.  It enables the debt market which provides another investment vehicle.  It enables expansion of capital intensive business.  Many small businesses are actually funded by loans on the proprietor's residence.  It permits leverage to increase risk and return.  It can be abused, but it can increase flexibility and power when well managed.  

Without a deduction, borrowing to invest would make much less sense.  Much lending would be driven to internal sources and much less money would be made available on the market without it.  It would tilt investing from debt towards equities.  Making some borrowing deductible and others not present another tax avoidance incentive since borrowing on deductible assets would then be diverted towards nondeductible assets.  Treating individuals and businesses differently create another tax avoidance scheme.  Real property is a productive asset despite assertions to the contrary.  

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