Is Borrowing Good for Business?

Businesses and governments borrow money for a number of reasons. The most important can be attributed to the fact that sufficient funds are not on hand to pay for the purchases that they are unable or unwilling to delay. Some purchases require a substantial amount of capital that would be impossible to raise without borrowing. Businesses borrow in order to procure raw materials or build factories. Governments borrow to build highways and pay for services demanded by their citizens. Sometimes borrowing is for the purpose of keeping one’s own cash reserves available for other investments and using someone else’s money to make necessary purchases, which can be financially advantageous.

Businesses are typically financed with a combination of borrowed money, ownership funds, and capital acquired from profits. Borrowing provides businesses with an additional source of funding to purchase productive assets, such as machinery and buildings, and to finance ongoing operations. Financing a company’s expansion with credit allows the existing owners to avoid having to bring in additional investors who would share in the eventual profits; the existing owners’ investment returns are thereby increased.

Businesses have an additional incentive to utilize credit because the interest that’s paid to lenders can be deducted from their federal and state income taxes. This causes businesses to generally favor debt over common stock, on which dividends must be paid to stockholders with after-tax income. In other words, those dividends are not tax-deductible.

Governments borrow when tax and fee collections are not sufficient to meet their spending requirements. At all levels, governments have relied more and more on borrowed funds to pay for the goods and services demanded by their constituencies. Although reliance on credit could be reduced by cutting back on spending and raising taxes, lawmakers have not embraced either of those options. This is undoubtedly due to the unpopularity with which either of these actions would be met by the public. Citizens lobby for the continuation and expansion of their own interests, while at the same time demanding that government spending be held in check or reduced.

A substantial amount of government spending is allocated to the construction or maintenance of bridges, buildings, monuments, and other long-lasting assets. Long-lifespans of assets such as these make it relatively easy to accept that they should be at least partially financed with borrowed funds, which allow the citizens to enjoy the use of them at the same time that the loans are being repaid.

The more difficult circumstance tends to be the use of credit by the government to support short-term assets. Financing short-term requirements with long-term debt commitments can present long-term financial problems due to the fact that citizens will be saddled with substantial repayment obligations long after any benefits have been exhausted. Using credit to pay for current social programs, especially programs that can be expected to require even larger financial commitments in future years, can also pose far-reaching financial hardships. For governments, long-term borrowing to support short-term spending needs causes future generations of taxpayers to have to pay for the excess spending habits of their parents and grandparents who consumed economic resources beyond their willingness to pay for them.