As Certain as Debt and Taxes: Estimating the Tax Sensitivity of Leverage from State Tax Changes
European Central Bank (ECB)
New York University (NYU) - Department of Finance; National Bureau of Economic Research (NBER); Centre for Economic Policy Research (CEPR); European Corporate Governance Institute (ECGI); Research Institute of Industrial Economics (IFN)
October 8, 2014
Journal of Financial Economics (JFE), Forthcoming
Using staggered corporate income tax changes across U.S. states, we show that taxes have a first-order effect on capital structure. Firms increase leverage by around 40 basis points for every percentage-point tax increase. Consistent with dynamic tradeoff theory, the effect is asymmetric: leverage does not respond to tax cuts. This is true even within firm: tax increases that are later reversed nonetheless lead to permanent leverage increases. The treatment effects are heterogeneous and confirm the tax channel: tax sensitivity is greater among profitable and investment-grade firms which respectively have a greater marginal tax benefit and lower marginal cost of issuing debt.
Number of Pages in PDF File: 73
Keywords: Capital structure, debt policy, leverage, leverage dynamics, taxes, tradeoff theory, dynamic capital structure models, natural experiments
JEL Classification: G32Accepted Paper Series
Date posted: March 18, 2012 ; Last revised: October 14, 2014
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