Have the Tax Benefits of Debt Been Overestimated?
56 Pages Posted: 5 Apr 2008 Last revised: 15 Nov 2011
Date Written: April 22, 2010
We re-examine the claim that many corporations are underleveraged in that they fail to take full advantage of debt tax shields. We show prior results suggesting underleverage stems from biased estimates of tax benefits from interest deductions. We develop improved estimates of marginal tax rates using a non-parametric procedure that produces more accurate estimates of the distribution of future taxable income. We show that additional debt would provide firms with much smaller tax benefits than previously thought, and when expected distress costs and difficult-to-measure non-debt tax shields are also considered, it appears plausible that most firms have tax-efficient capital structures.
Keywords: capital structure, debt, marginal tax rates, corporate taxes
JEL Classification: H20, M41, G31, G32
Suggested Citation: Suggested Citation