How Will the TCJA of 2017 Change the Tax Benefits of Debt? – The Unintended Industry Effect of the Cap on Interest Expense

45 Pages Posted: 11 Sep 2020

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: 2020

Abstract

Using a production-based structural model, calibrated with data for the period 2001-2017, we find that the cap on the deduction of interest expense enshrined in the Tax Cuts and Jobs Act of 2017 reduces the net tax benefits of debt differentially across industries by 1% to 2.2% of un-levered firm-value on average. The new tax provisions make firms’ current capital structure policies considerably less conservative - a typical firm can double its existing interest burden compared to increasing it more than six-fold earlier, before marginal net tax benefits decline; the impact is larger for capital intensive industries that employ more leverage. A change in the mix of factor inputs, that depends on technology flexibility in that industry, can preserve a part of the tax benefits in some industries. Collectively our results show that the well documented positive relationship between firm leverage and physical capital employed will decline on average.

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 Will the TCJA of 2017 Change the Tax Benefits of Debt? – The Unintended Industry Effect of the Cap on Interest Expense (2020). 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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