Corporate vs Personal Income Taxes Compared with other ways of funding the government, the corporate tax is particularly

hard on economic growth. A C.B.O. report in 2005 concluded that the distortions that the corporate income tax induces are large compared with the revenues that the tax generates. Reducing these distortions would lead to better-paying jobs. Of course, a corporate tax cut would affect the federal budget. And any change in tax policy has to be made against a background of a looming fiscal crisis, which threatens to unfold as baby boomers retire and start collecting Social Security and Medicare. In 2007, corporate taxes brought in $370 billion, representing 14 percent of federal revenue. Cutting the rate to 25 percent would seem to cost the Treasury about $100 billion a year. Part of that revenue loss, however, would be recouped through other taxes. To the extent that shareholders would benefit, they would pay higher taxes on dividends, capital gains and withdrawals from their retirement accounts. To the extent that workers would benefit, they would pay higher payroll and income taxes. Increased economic growth would tend to raise tax revenue from all sources. A firm finances its activities using funds from debt and equity. Debt refers to loans the firm secures from outside sources. Equity refers money the firm's owners or stockholders invest in the firm. A firm's capital structure is its ratio of long-term debt to equity. An optimalcapital structure is the best debt-to-equity ratio for the firm, which minimizes the cost of financing and maximizes the value of the firm. According to the trade-off theory, the cost of debt is always lower than the cost of equity, because interest on debt is tax-deductible. The cost of equity usually consists of dividends the firm distributes to its owners or shareholders dividends the firm could delay or reduce. Debt-holders have a prior claim to the firm's funds, and the firm can only pay shareholders after meeting its debt obligations for the period. Debt is cheaper but carries with it the risk of not being able to make payments on time, which could result inbankruptcy. The firm, therefore, has to find an optimal capital structure that minimizes the cost of financing while also minimizing the risk of bankruptcy. Definition of 'Optimal Capital Structure' The best debt-to-equity ratio for a firm that maximizes its value. The optimal capital structure for a company is one which offers a balance between the ideal debt-to-equity range and minimizes the firm's cost of capital. In theory, debt financing generally offers the lowest cost of capital due to its tax deductibility. However, it is rarely the optimal structure since a company's risk generally increases as debt increases. Investopedia explains 'Optimal Capital Structure' A company's ratio of short and long-term debt should also be considered when examining its capital structure. Capital structure is most often referred to as a firm's debt-to-equity ratio, which provides insight into how risky a company is for potential investors. Determining an optimal capital is a chief requirement of any firms corporate finance department. Capital structure with a minimum weighted-average cost of capital and thereby maximizes the value of the firm's stock, but it does not maximize earnings per share (EPS). Greater leverage maximizes EPS but also increases risk. Thus, the highest stock price is not reached by maximizing EPS. The optimal capital structure usually involves some debt, but not 100% debt. Ordinarily, some firms cannot identify this optimal point precisely, but they should attempt to find an optimal range for the capital structure. The required rate of return on equity capital (R) can be estimated in various ways, for example, by adding a percentage to the firm's long-term cost of debt.Another method is the capital asset pricing model (capm). Introduction Perfect capital markets enjoy an array of assumptions, including no cost to bankruptcy, infinitely divisible financial assets and liabilities, no transaction costs, etc. Pursuing a selected optimal capital structure would allow minute adjustments, the issuance or redemption of small amounts of capital, and other conveniences. We would simply strive for the optimal debt/equity ratio depicted in Figure 1. Indeed, in this unreal world one would keep all the equity for control and to maximize wealthand employ massive amounts of debt. Imperfect Capital Markets The rudeness of imperfect markets prompts us to adopt a reasonable strategy that allows one to benefit from the tenets of capital structure theory while respecting the reality of markets and economies. Imperfect capital markets, bankruptcy costs, and that a company with financial flexibility may have attractive opportunities during periods of adverse market conditions argue for a strategy for the management of capital structure. Additionally, capital market participants may value a company with the financial flexibility that would allow it to pursue opportunities even (or especially) during periods of high market stress. A company with financial flexibility may find bargains during periods of distress. In this article we first address background issues. Then we will move to recommendations. We will see that the suggested strategy does not seek to have the theoretical optimal debt/equity (D/E) ratio. Good and Bad Debt Capacity A company that has a less than optimal D/E ratio has unused good capacity. Normally a company with good debt capacity can borrow quickly on favorable terms to pursue an attractive opportunity. Thus, it can obtain capital quickly without the delays or possible undesirability of an equity offering.