The Tax Advantage of Corporate Debt after Tax Reform: A Direct Test of the Effect of Anticipated Tax Rate Changes on Corporate Leverage
Posted: 24 Oct 1999
Date Written: September 1994
The Tax Reform Act of 1986 (TRA86) provided a natural experiment for analyzing the influence of taxes on corporate leverage decisions. A centerpiece of TRA86 was the lowering of the maximum statutory corporate marginal tax rate facing corporations from 46 percent to 34 percent accompanied by broad changes in the tax base, and the curtailment or elimination of numerous tax shields.This paper uses direct estimates of the effects of the tax changes on corporate marginal tax rates, focusing on the tax savings from increased leverage, and provides an estimate of the extent anticipated changes in marginal tax rates influenced corporate leverage decisions. The results show TRA86 was expected to decrease average marginal tax rates approximately 5 percentage points and decrease the dispersion of tax rates across industries. The second half of the paper tests whether the anticipated marginal tax rate changes had an effect on corporate leverage. The estimates provide support for the role of corporate taxation in firms' leverage decisions, and quantify the leverage changes in response to TRA86. In addition, since the effects of the tax change are measured directly, rather than through a proxy, an estimate of the magnitude of such changes can be made. Corporate debt in 1988 is estimated to have been $312 billion lower than it would have been in the absence of TRA86.
JEL Classification: G3, H2
Suggested Citation: Suggested Citation