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Pouring oil on fire: interest deductibility and corporate debt

Author

Listed:
  • Pietro Dallari

    (International Monetary Fund)

  • Nicolas End

    (International Monetary Fund)

  • Fedor Miryugin

    (International Monetary Fund)

  • Alexander F. Tieman

    (International Monetary Fund)

  • Seyed Reza Yousefi

    (International Monetary Fund)

Abstract

This paper investigates the role of tax incentives towards debt finance in the buildup of leverage in the nonfinancial corporate (NFC) sector, using a large firm-level dataset. We find that so-called debt bias is a significant driver of leverage, for both small and medium-sized enterprises and larger firms, with its effect accounting for up to a quarter of total leverage. These findings support the tradeoff theory of capital structure. We furthermore explore what firm traits affect these results, documenting how the strength of this effect differs with firm size, the availability of collateral, income and income volatility, cash flow, and capital intensity. We conclude that leveling the playing field between debt and equity finance through tax policy reform would decrease NFC leverage.

Suggested Citation

  • Pietro Dallari & Nicolas End & Fedor Miryugin & Alexander F. Tieman & Seyed Reza Yousefi, 2020. "Pouring oil on fire: interest deductibility and corporate debt," International Tax and Public Finance, Springer;International Institute of Public Finance, vol. 27(6), pages 1520-1556, December.
    • Handle: RePEc:kap:itaxpf:v:27:y:2020:i:6:d:10.1007_s10797-020-09604-7
    DOI: 10.1007/s10797-020-09604-7
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    1. Abraham,Facundo & Cortina Lorente,Juan Jose & Schmukler,Sergio L., 2020. "Growth of Global Corporate Debt : Main Facts and Policy Challenges," Policy Research Working Paper Series 9394, The World Bank.
    2. Baines, Joseph & Hager, Sandy Brian, 2021. "The Great Debt Divergence and its Implications for the Covid-19 Crisis: Mapping Corporate Leverage as Power," EconStor Open Access Articles and Book Chapters, ZBW - Leibniz Information Centre for Economics, issue Latest Ar.
    3. Basha, Shabeen Afsar & Bennasr, Hamdi & Goaied, Mohamed, 2023. "Financial literacy, financial development, and leverage of small firms," International Review of Financial Analysis, Elsevier, vol. 86(C).
    4. Thomas Url & Klaus S. Friesenbichler & Werner Hölzl, 2019. "Quellen der Unternehmensfinanzierung in Österreich," WIFO Studies, WIFO, number 61642, April.

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    More about this item

    Keywords

    Leverage; Debt Bias; Tax Policy; Corporate Income Tax; SMEs; Micro data;
    All these keywords.

    JEL classification:

    • H25 - Public Economics - - Taxation, Subsidies, and Revenue - - - Business Taxes and Subsidies
    • H32 - Public Economics - - Fiscal Policies and Behavior of Economic Agents - - - Firm
    • D22 - Microeconomics - - Production and Organizations - - - Firm Behavior: Empirical Analysis
    • 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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