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

Florian Heider

European Central Bank (ECB); Centre for Economic Policy Research (CEPR)

Alexander Ljungqvist

New York University (NYU) - Department of Finance; National Bureau of Economic Research (NBER); Centre for Economic Policy Research (CEPR); European Corporate Governance Institute (ECGI); Research Institute of Industrial Economics (IFN)

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, 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

European Central Bank (ECB) ( email )

Sonnemannstrasse 22
Frankfurt am Main, 60314
Germany

HOME PAGE: http://https://sites.google.com/site/florianheider2/

Centre for Economic Policy Research (CEPR) ( email )

77 Bastwick Street
London, EC1V 3PZ
United Kingdom

Alexander Ljungqvist (Contact Author)

New York University (NYU) - Department of Finance ( email )

Stern School of Business
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New York, NY 10012-1126
United States
212-998-0304 (Phone)
212-995-4220 (Fax)

HOME PAGE: http://pages.stern.nyu.edu/~aljungqv

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Centre for Economic Policy Research (CEPR)

77 Bastwick Street
London, EC1V 3PZ
United Kingdom

European Corporate Governance Institute (ECGI)

c/o ECARES ULB CP 114
B-1050 Brussels
Belgium

Research Institute of Industrial Economics (IFN) ( email )

Box 55665
Grevgatan 34, 2nd floor
Stockholm, SE-102 15
Sweden

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