How Does a Cap on Interest Expense Change the Tax Benefits of Debt?

58 Pages Posted: 11 Sep 2020 Last revised: 21 Dec 2021

See all articles by Karan Bhanot

Karan Bhanot

University of Texas at San Antonio - Department of Finance

Pascal Francois

HEC Montreal - Department of Finance

Palani-Rajan Kadapakkam

University of Texas at San Antonio - Department of Finance

Date Written: 2021

Abstract

Using a production-based structural model, calibrated with U.S. data for the period 2001-2017, we find that for the typical firm an EBIT-based cap on the deduction of interest reduces the tax benefits of debt by 1% of unlevered firm value. This impact differs across industries ranging from a decline of 0.3% to 3.7% of unlevered firm value. Industry specific capital to labor ratio is a key driver of these effects. A typical firm’s marginal tax benefit declines from 14.3% to 7.8% of unlevered firm value. An EBITDA-based cap reduces the differential impact across industries.

Keywords: Tax Cuts and Jobs Act, Tax Benefits

JEL Classification: G1, G32, G33

Suggested Citation

Bhanot, Karan and Francois, Pascal and Kadapakkam, Palani-Rajan, How Does a Cap on Interest Expense Change the Tax Benefits of Debt? (2021). Available at SSRN: https://ssrn.com/abstract=3660913 or http://dx.doi.org/10.2139/ssrn.3660913

Karan Bhanot (Contact Author)

University of Texas at San Antonio - Department of Finance ( email )

San Antonio, TX 78249
United States
210-458-7429 (Phone)
210-458-5837 (Fax)

Pascal Francois

HEC Montreal - Department of Finance ( email )

3000 Chemin de la Cote-Sainte-Catherine
Montreal, Quebec H3T 2A7
Canada
514-340-7743 (Phone)
514-340-5632 (Fax)

Palani-Rajan Kadapakkam

University of Texas at San Antonio - Department of Finance ( email )

San Antonio, TX 78249
United States

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