DefinePK

Abstract

Income taxes treat interest either as cost or as income. It is a cost when borrowed funds are used to generate a taxable stream of income, justifying deductibility. When it is an accretion to income, interest is liable to taxation. Interest income, it may be pointed out, has been viewed as unearned income compared with earned, wage income right from the days of Adam Smith, furnishing the basis for higher taxation of the former. However, the cost and income concepts are not strictly adhered to. In the United States, the so-called tax expenditures have resulted from these departures, first, by allowing tax deductibility without interest being a cost of producing taxable income and, secondly, by exempting interest income from state-local securities despite accretion to taxable income. All these interest categories have interesting implications for efficiency, equity, investment pattern and corporate financial structure. The present paper seeks to spell out some of these in the context the United States insofar as there are lessons for the debate on riba.