How Does Removing the Tax Benefits of Debt Affect Firms? Evidence from the 2017 US Tax Reform

57 Pages Posted: 8 Jul 2021 Last revised: 21 Oct 2021

Date Written: October 20, 2021

Abstract

Despite extensive efforts, the impact of the tax benefits of debt on firm decisions is an open question. The 2017 US tax reform creates an opportunity to directly estimate the effects. The reform limits the tax advantage of debt for all firms except for small businesses with average sales below $25 million. I use the exception threshold in a regression discontinuity design and show that corporate debt declines nearly dollar for dollar as the present value of the tax benefits of debt shrinks, but equity financing is not affected. Treated firms decrease their investments and hiring, consistent with the rise in the cost of external financing. The effects are similar in public and private companies. Although the new law disproportionately reduces the tax benefits of debt in small firms, the evidence suggest that the estimates likely provide a lower bound for the effects in large companies. Overall, I document a first-order role for tax incentives that affect the cost of capital in shaping corporate financial and real policies.

Keywords: Tax Cut and Jobs Act, Interest Deductions, Capital Structure, Hiring and Investments, Trade-off Theory, Business Taxes and Subsidies

JEL Classification: G31, G32, G38, H25, K34

Suggested Citation

Sanati, Ali, How Does Removing the Tax Benefits of Debt Affect Firms? Evidence from the 2017 US Tax Reform (October 20, 2021). Available at SSRN: https://ssrn.com/abstract=3878363 or http://dx.doi.org/10.2139/ssrn.3878363

Ali Sanati (Contact Author)

American University ( email )

4400 Massachusetts Avenue NW
Washington, DC 20816-8044
United States

Do you have a job opening that you would like to promote on SSRN?

Paper statistics

Downloads
180
Abstract Views
591
rank
216,198
PlumX Metrics