Necessity, we are reminded, is the mother of invention. Shearson Lehman Hutton's new brainstorm, the "unbundled stock unit" (USU), illustrates the tremendous pressure on Wall Street to find new avenues out of the takeover craze. Best described in Monday's "Market Place" column by Floyd Norris of The New York Times, the trading vehicle would permit shareholders to trade a common share into its three component parts — roughly pure equity, pure debt, and a warrant, the magic of which elevates the value of the bundle by economizing on taxes. The income stream that flows from a common share would reduce tax liabilities of the corporation as it deducts interest payments. The "junk bond" element of the common share thus goes directly to the shareholder instead of being wheeled though the pockets of KKR and Co.
Pressure to "level the playing field" for debt and double-taxed equity has heightened with the RJR Nabisco deal, with calculations that the U.S. Treasury will subsidize $7 billion of the $25 billion package by foregone taxes on profits. When Fed Chairman Alan Greenspan fingered the tax devil that is making the LBO boys do it, the markets became skittish about "remedies" that might double tax debt as well as equity. The USU, and variations that follow as Wall Street further runs up this learning curve, may actually force action in the right direction: a cut in the capital gains tax. The hypothesis, of course, is that the 50% increase in that tax rate, which was the price the administration paid to lower marginal rates, added immense pressure to restructure corporate America. Equity suddenly became much less attractive than debt, playing into the hands of the junk-bond, M&A strategists. The obscene, outrageous billions in fees accompanying these deals may turn out, as always, to serve a useful purpose, greed driving everyone who is not getting a cut, including the government, into dreaming up ways to do so. Shearson charges 2% fees for doing USU deals. A cut in the capital gains tax avoids even these fees by leveling the debt-equity field upward.
The chief impediment to a 15% capital gains tax, which George Bush pledged in his campaign, is not the Democratic Congress. Today, as when it was cut to 28% ten years ago (at the instigation of the late Rep. William Steiger), the chief opposition comes from the boardrooms of the Fortune 500, the Business Roundtable, etc. They have already implanted the idea that President Bush will have to indefinitely put off his pledge on capital gains in order to deal with the budget deficit. In the struggle for the soul of Mr. Bush, still embraced by the entrepreneurial class, the corporate elites are still gnawing away. But if the elites are willing to devise poison pills to slow the deconglomeration of America, perhaps they are now willing to relax on capital gains. A cut in the rate to 15% would of course elevate equities, capturing hidden assets for the shareholders instead of KKR or Nabisco's Ross Johnson. The employees of corporate America would of course benefit too, the threat of tax-driven perestroika much reduced.
The Democratic Congress, awaiting a budget plan from the President-elect to deal with the federal deficit, has steeled itself against a cut in capital gains, insisting it would have to be paid for by a hike in marginal rates. The most painless solution to the dilemma raised by GB's read-my-lips pledge, though, would be such a cut paid for by raising proportional tax rates (excises) instead of the progressive rates that Bush will have to defend with heart and soul. As any Democrat will secretly admit, the capital gains cut will also produce, not lose, revenue. The battle will soon be joined, the entrepreneurial class in the hands of OMB Director-to-be Richard Darman, now a managing director of Shearson Lehman Hutton, the shop that invented the USU. We wish him luck.