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The effect of debt tax benefits on firm investment decisions

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  • Addessi, William
  • Saltari, Enrico

Abstract

In this paper we question the idea that the deduction of debt interest is always an effective policy instrument to spur firm investment. We analyze the investment decision in presence of a borrowing constraint on the amount of the debt that the firm can raise. We show that if the debt interest rate is decreasing in the firm capital accumulation and it is available another financial resource more expensive than debt (at least for levels of debt lower than the upper bound), then the deduction of the debt interest from taxes on capital income may reduce firm investment. This theoretical result should be considered when financial intermediaries are not willing to finance beyond a certain threshold but firms have access to other sources of finance.

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Bibliographic Info

Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 35436.

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Date of creation: 17 Dec 2011
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Handle: RePEc:pra:mprapa:35436

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Keywords: Corporate taxation; Financing constraints; Investment;

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  1. Sangeeta Pratap & Silvio Rendón, 1996. "Firm investment in imperfect capital markets: A structural estimation," Economics Working Papers 274, Department of Economics and Business, Universitat Pompeu Fabra, revised Mar 1998.
  2. Toni M. Whited, 1990. "Debt, liquidity constraints, and corporate investment: evidence from panel data," Finance and Economics Discussion Series 114, Board of Governors of the Federal Reserve System (U.S.).
  3. Enrico Saltari & Davide Ticchi, 2002. "Risk aversion, intertemporal substitution, and the aggregate investment-uncertainty relationship," Working Papers 69, University of Rome La Sapienza, Department of Public Economics.
  4. Saltari, Enrico & Ticchi, Davide, 2005. "Risk-aversion and the investment-uncertainty relationship: a comment," Journal of Economic Behavior & Organization, Elsevier, vol. 56(1), pages 121-125, January.
  5. Saltari Enrico & Travaglini Giuseppe, 2003. "How Do Future Constraints Affect Current Investment?," The B.E. Journal of Macroeconomics, De Gruyter, vol. 3(1), pages 1-21, June.
  6. Steven M. Fazzari & R. Glenn Hubbard & BRUCE C. PETERSEN, 1988. "Financing Constraints and Corporate Investment," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 19(1), pages 141-206.
  7. John R. Graham, 2003. "Taxes and Corporate Finance: A Review," Review of Financial Studies, Society for Financial Studies, vol. 16(4), pages 1075-1129.
  8. Roger H. Gordon & Young Lee, 1999. "Do Taxes Affect Corporate Debt Policy? Evidence from US Corporate Tax Return Data," NBER Working Papers 7433, National Bureau of Economic Research, Inc.
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