Traditional capitalism, in which firms raise capital from investors and use it to grow their businesses, while returning some share of the profits as dividends, works brilliantly to deliver economic growth and prosperity. But it is no longer working in America. Firms are now disgorging capital much faster than they raise it and, in many cases, so quickly that they cannibalize their existing operations. They do this primarily through share buybacks rather than dividends, which allows them to increase stock-based compensation to executives, manipulate their stock price, and help investors defer tax liability. Share buybacks top $1 trillion annually and exceed dividend payments by two-to-one. Economy-wide, business investment has fallen significantly as a share of GDP.

Firms also have a substantial incentive to raise capital through debt rather than equity, because interest payments can be deducted from taxable profits while dividends and share buybacks cannot. The best illustration of the tax code’s bias comes from a 2014 analysis by the Congressional Budget Office, which found that a corporation financed entirely by equity investment would face an overall effective tax rate of 38%, while one financed entirely by borrowing would face a rate of -6%. (The Tax Cuts and Jobs Act of 2017 affected these rates somewhat.) Private equity firms take particular advantage of these provisions, performing leveraged buyouts that load firms with dangerously high debt loads while offering the promise of much higher investor returns if all goes well. When all does not go well, the risk of bankruptcy is much higher—and it is the workers and communities reliant on those firms that bear the highest cost.

The United States should discourage financial engineering and push capital markets back toward their necessary, traditional role by banning share buybacks and eliminating the deductibility of interest. Share buybacks are not inherent to our capitalist system; they are the direct result of a decision by the Reagan administration in 1982 to promulgate SEC Rule 10b-18, which gives a safe harbor from insider-trading and market-manipulation rules for such buybacks. But of course, a firm deciding to buy its own shares on the open market is the very definition of insider trading. As for interest deductibility, the argument that taxes should apply only to profits and profits are calculated after interest has been paid merely begs the question. The tax system can just as well define profit as a business’s earnings before interest and taxes have been paid. Indeed, Earnings Before Interest and Taxes (“EBIT”) is a standard metric reported on the income statement and is commonly referred to as “operating profit.”