As Certain as Debt and Taxes: Estimating the Tax Sensitivity of Leverage from State Tax Changes

73 Pages Posted: 18 Mar 2012 Last revised: 24 May 2016

See all articles by Florian Heider

Florian Heider

Leibniz Institute for Financial Research SAFE; Goethe University Frankfurt; Centre for Economic Policy Research (CEPR)

Alexander Ljungqvist

Centre for Economic Policy Research (CEPR); Swedish House of Finance; European Corporate Governance Institute (ECGI)

Multiple version iconThere are 4 versions of this paper

Date Written: October 8, 2014

Abstract

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.

Keywords: Capital structure, debt policy, leverage, leverage dynamics, taxes, tradeoff theory, dynamic capital structure models, natural experiments

JEL Classification: G32

Suggested Citation

Heider, Florian and Ljungqvist, Alexander and Ljungqvist, Alexander, As Certain as Debt and Taxes: Estimating the Tax Sensitivity of Leverage from State Tax Changes (October 8, 2014). Journal of Financial Economics (JFE), 118, 684-712 (2015), Available at SSRN: https://ssrn.com/abstract=2024200 or http://dx.doi.org/10.2139/ssrn.2024200

Florian Heider

Leibniz Institute for Financial Research SAFE ( email )

House of Finance
Theodor-W.-Adorno-Platz 3
Frankfurt, 60323
Germany

Goethe University Frankfurt ( email )

Finance Department
Theodor-W.-Adorno-Platz 3
Frankfurt am Main, 60323
Germany

Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

Alexander Ljungqvist (Contact Author)

Centre for Economic Policy Research (CEPR)

London
United Kingdom

Swedish House of Finance ( email )

Drottninggatan 98
111 60 Stockholm
Sweden

European Corporate Governance Institute (ECGI)

c/o the Royal Academies of Belgium
Rue Ducale 1 Hertogsstraat
1000 Brussels
Belgium

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