Differential Taxation and Firms' Financial Leverage: Evidence from the Introduction of a Flat Tax on Interest Income

47 Pages Posted: 29 Feb 2012

See all articles by Frank M. Fossen

Frank M. Fossen

University of Nevada, Reno; IZA Institute of Labor Economics

Martin Simmler

University of Oxford - Oxford University Centre for Business Taxation; German Institute for Economic Research (DIW Berlin)

Date Written: February 1, 2012

Abstract

Tax competition for the mobile factor capital has led to a trend in many countries to levy lower taxes on interest income, often introducing differential taxation between interest and business income. In this study, we analyze the effect of such differential taxation on the debt ratio of firms. We exploit a 2009 tax reform in Germany as a quasi-experiment, which introduced a flat final withholding tax and opened a gap of 18 percentage points between the tax rate on income from unincorporated businesses and the new lower tax rate on interest income. We apply a regression adjusted semi-parametric difference-in-difference matching strategy based on firm level panel data. In addition, we implement a more structural approach with a tax rate differential, taking into account its endogeneity by using instrumental variables. The results indicate that firms increase their leverage when the tax rate on interest income decreases, albeit to a small degree.

Keywords: income taxation, capital taxation, financial structure, leverage, matching

JEL Classification: H25, H24, G32

Suggested Citation

Fossen, Frank M. and Simmler, Martin, Differential Taxation and Firms' Financial Leverage: Evidence from the Introduction of a Flat Tax on Interest Income (February 1, 2012). DIW Berlin Discussion Paper No. 1190, Available at SSRN: https://ssrn.com/abstract=2013074 or http://dx.doi.org/10.2139/ssrn.2013074

Frank M. Fossen

University of Nevada, Reno ( email )

1664 N. Virginia Street
Reno, NV 89557-0030
United States

HOME PAGE: http://business.unr.edu/faculty/ffossen/

IZA Institute of Labor Economics

P.O. Box 7240
Bonn, D-53072
Germany

HOME PAGE: http://www.iza.org/en/webcontent/personnel/photos/index_html?key=2906

Martin Simmler (Contact Author)

University of Oxford - Oxford University Centre for Business Taxation ( email )

Saïd Business School
Park End Street
Oxford, OX1 1HP
United Kingdom

German Institute for Economic Research (DIW Berlin) ( email )

Mohrenstraße 58
Berlin, 10117
Germany

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