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Look at Macy's: U.S. tax code encourages companies to rack up huge debt

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By David Cho
Washington Post Staff Writer
Sunday, August 8, 2010

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.

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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."


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