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As certain as debt and taxes: Estimating the tax sensitivity of leverage from state tax changes

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  • Heider, Florian
  • Ljungqvist, Alexander

Abstract

Using staggered corporate income tax changes across U.S. states, we show that taxes have a first-order effect on capital structure. Firms increase leverage by around 40 basis points for every percentage-point tax increase. Consistent with dynamic tradeoff theory, the effect is asymmetric: leverage does not respond to tax cuts. This is true even within-firm: tax increases that are later reversed nonetheless lead to permanent leverage increases. The 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 & Ljungqvist, Alexander, 2015. "As certain as debt and taxes: Estimating the tax sensitivity of leverage from state tax changes," Journal of Financial Economics, Elsevier, vol. 118(3), pages 684-712.
    • Handle: RePEc:eee:jfinec:v:118:y:2015:i:3:p:684-712
    DOI: 10.1016/j.jfineco.2015.01.004
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    More about this item

    Keywords

    Capital structure; Taxes; Tradeoff theory; Dynamic capital structure models; Natural experiments;
    All these keywords.

    JEL classification:

    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill

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