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Differential Taxation and Firms' Financial Leverage: Evidence from the Introduction of a Flat Tax on Interest Income

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  • Frank M. Fossen
  • Martin Simmler

Abstract

Tax competition for the mobile factor capital has led to a trend in many countries to levy lower taxes on interest income, often introducing differential taxation between interest and business income. In this study, we analyze the effect of such differential taxation on the debt ratio of firms. We exploit a 2009 tax reform in Germany as a quasi-experiment, which introduced a flat final withholding tax and opened a gap of 18 percentage points between the tax rate on income from unincorporated businesses and the new lower tax rate on interest income. We apply a regression adjusted semi-parametric difference-in-difference matching strategy based on firm level panel data. In addition, we implement a more structural approach with a tax rate differential, taking into account its endogeneity by using instrumental variables. The results indicate that firms increase their leverage when the tax rate on interest income decreases, albeit to a small degree.

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Bibliographic Info

Paper provided by DIW Berlin, German Institute for Economic Research in its series Discussion Papers of DIW Berlin with number 1190.

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Length: 45 p.
Date of creation: 2012
Date of revision:
Handle: RePEc:diw:diwwpp:dp1190

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Keywords: Income taxation; capital taxation; financial structure; leverage; matching;

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References

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Cited by:
  1. Hermann Buslei & Martin Simmler, 2012. "The Impact of Introducing an Interest Barrier: Evidence from the German Corporation Tax Reform 2008," Discussion Papers of DIW Berlin 1215, DIW Berlin, German Institute for Economic Research.
  2. Serena Fatica & Thomas Hemmelgarn & Gaetan Nicodeme, 2013. "The Debt-Equity Tax Bias: Consequences and Solutions," Reflets et perspectives de la vie économique, De Boeck Université, vol. 0(1), pages 5-18.

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