NCPA - National Center for Policy Analysis

Tax Code Deserves Some Blame For Enron's Collapse

February 6, 2002

Incentives in the U.S. Tax Code encouraged Enron to take steps that increased the risk of bankruptcy, says Bruce Bartlett.

The United States taxes corporations more heavily than any other major country; thus U.S. corporations exploit every opportunity for tax relief.

Since interest payments on corporate debt are a deductible business expense, whereas dividends are not, it is far more attractive for companies to raise capital by selling debt than by issuing new common stock.

  • In 1960, nonfinancial U.S. corporations paid out more than twice as much money in the form of dividends as they paid out in interest.
  • By 1997, they were paying out 40 percent more in interest than in dividends.
  • Not surprisingly, U.S. corporations have become highly leveraged, with $4.7 trillion in debt outstanding at the end of 2000.

In bad economic times, when corporate cash flow declines due to falling sales, a heavy debt load can trigger bankruptcies.

Enron issued de facto equity that looked enough like a bond to allow dividend payments to be deductible as interest, while increasing its leverage without appearing to do so.

For these extremely complex transactions, Enron set up hundreds of partnerships in foreign tax havens -- which were repeatedly challenged by the Internal Revenue Service. However, the Tax Court ruled in Enron's favor, and the Clinton Administration's efforts to get a legislative fix failed.

Thus, Enron paid no federal income taxes in 4 out of 5 years between 1996 and 2000, according to Citizens for Tax Justice. It was also able to borrow vast sums, greatly increasing it leverage, without such borrowing showing up where analysts and bond rating agencies could see it. When the recession hit and energy prices collapsed, Enron's financial house of cards came tumbling down.

Source: Bruce Bartlett, senior fellow, National Center for Policy Analysis, February 6, 2002.


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