73 Pages Posted: 18 Mar 2012 Last revised: 24 May 2016
Date Written: October 8, 2014
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: Suggested Citation
Heider, Florian 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