As Certain as Debt and Taxes: Estimating the Tax Sensitivity of Leverage from Exogenous State Tax Changes

75 Pages Posted: 28 Jul 2012 Last revised: 25 Nov 2024

See all articles by Florian Heider

Florian Heider

Leibniz Institute for Financial Research SAFE; Goethe University Frankfurt; Centre for Economic Policy Research (CEPR)

Alexander Ljungqvist

Centre for Economic Policy Research (CEPR); Swedish House of Finance; European Corporate Governance Institute (ECGI)

Multiple version iconThere are 4 versions of this paper

Date Written: July 2012

Abstract

We use a natural experiment in the form of 121 staggered changes in corporate income tax rates across U.S. states to show that tax considerations are a first-order determinant of firms' capital structure choices. Over the period 1990-2011, firms increase long-term leverage by 104 basis points on average (or $32.5 million in extra debt) in response to an average tax increase of 131 basis points. Contrary to static trade-off theory, the tax sensitivity of leverage is asymmetric: firms do not reduce leverage in response to tax cuts. Using treatment reversals, we find this to be true even within-firm: tax increases that are later reversed nonetheless lead to permanent increases in a firm's leverage - an unexpected and novel form of hysteresis. Our findings are robust to various confounds such as unobserved variation in local business conditions, union power, or unemployment risk. 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.

Suggested Citation

Heider, Florian and Ljungqvist, Alexander and Ljungqvist, Alexander, As Certain as Debt and Taxes: Estimating the Tax Sensitivity of Leverage from Exogenous State Tax Changes (July 2012). NBER Working Paper No. w18263, Available at SSRN: https://ssrn.com/abstract=2119038

Florian Heider (Contact Author)

Leibniz Institute for Financial Research SAFE ( email )

House of Finance
Theodor-W.-Adorno-Platz 3
Frankfurt, 60323
Germany

Goethe University Frankfurt ( email )

Finance Department
Theodor-W.-Adorno-Platz 3
Frankfurt am Main, 60323
Germany

Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

Alexander Ljungqvist

Swedish House of Finance ( email )

Drottninggatan 98
111 60 Stockholm
Sweden

Centre for Economic Policy Research (CEPR)

London
United Kingdom

European Corporate Governance Institute (ECGI)

c/o the Royal Academies of Belgium
Rue Ducale 1 Hertogsstraat
1000 Brussels
Belgium

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