Is Professor Miller’s personal tax model relevant in today’s tax environment?

Miller’s personal tax model examined the effect of personal income taxes on the debt-equity mix decision. He observed that personal income taxes in the U.S. favor equity financing since profits from equity investments come primarily in the form of capital gains which are taxed later and at potentially lower rates than interest income from debt investments. Miller determined that the bias in personal income taxes toward equity essentially offset the bias toward debt in the corporate income tax code and concluded that this supported the original MM conclusion that the financing mix is irrelevant to a company’s value. Since the time Miller wrote, the difference between the tax rates on ordinary income and capital gains has narrowed, somewhat weakening his argument. With today’s personal tax rate structure, it is likely that the bias toward debt from the corporate income tax dominates the favoring of equity by personal taxes. However, some politicians continue to advocate for further reductions in capital gains tax rates; if this happens, we will once again move closer to Miller’s conclusions.

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