When Tax Shields Shrink: Interest Deductibility Limitations and Corporate Innovation

Abstract

We investigate how limiting interest deductibility, as mandated by the 2017 Tax Cuts and Jobs Act, shapes corporate innovation. Using alternative identification strategies, we show that, relative to unaffected firms, affected firms experience significant declines in patent quantity and quality, and narrow the technological scope of their patent portfolios. Crosscountry evidence from the enactment of interest-ceiling rules confirms similar effects. The limitation increases firms' tax burden and, more substantially, induces deleveraging, curtailing their capacity for innovative investment. This exposes a novel financing channel linking corporate taxation to innovation, with the debt tax shield functioning as an implicit subsidy.

Keywords: Corporate Taxes, Corporate Innovation, Limitations on Interest Deductibility