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Do personal taxes affect capital structure? Evidence from the 2003 tax cut

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  • Lin, Leming
  • Flannery, Mark J.

Abstract

Because the personal tax treatments of interest and dividend income likely affect the relative cost of debt and equity financing, a sharp change in tax treatment could affect firms' optimal leverage. This paper examines the effect of the 2003 equity income tax cut on firms' debt usage. Because this tax cut affected only individual investors, we can use a difference-in-differences method to identify the effect of personal tax on firms' leverage. Previous research has found that the 2003 tax cut encouraged dividend payouts and reduced the cost of equity, but it provides no link to equilibrium leverage ratios. We estimate that the tax cut causes the affected firms' leverage to decrease by about 5 percentage points. Furthermore, we show that the effects of the tax cut are stronger for firms with lower marginal corporate tax rates and for firms that are not financially constrained, consistent with our theoretical predictions. Overall, we find strong evidence that personal tax is an important determinant of firms' optimal leverage.

Suggested Citation

  • Lin, Leming & Flannery, Mark J., 2013. "Do personal taxes affect capital structure? Evidence from the 2003 tax cut," Journal of Financial Economics, Elsevier, vol. 109(2), pages 549-565.
  • Handle: RePEc:eee:jfinec:v:109:y:2013:i:2:p:549-565
    DOI: 10.1016/j.jfineco.2013.03.010
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    References listed on IDEAS

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    Citations

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    Cited by:

    1. 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.
    2. repec:kap:itaxpf:v:26:y:2019:i:4:d:10.1007_s10797-019-09536-x is not listed on IDEAS
    3. repec:eee:corfin:v:50:y:2018:i:c:p:402-423 is not listed on IDEAS
    4. Mahito Okura & Satoru Yamaguchi, 2016. "Capital Structure of Non-life Insurance Firms in Japan," Applied Economics and Finance, Redfame publishing, vol. 3(3), pages 45-49, August.
    5. Florian Heider & Alexander Ljungqvist, 2012. "As Certain as Debt and Taxes: Estimating the Tax Sensitivity of Leverage from Exogenous State Tax Changes," NBER Working Papers 18263, National Bureau of Economic Research, Inc.
    6. repec:eee:advacc:v:34:y:2016:i:c:p:55-63 is not listed on IDEAS

    More about this item

    Keywords

    Capital structure; Personal taxes; Individual ownership;

    JEL classification:

    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
    • H24 - Public Economics - - Taxation, Subsidies, and Revenue - - - Personal Income and Other Nonbusiness Taxes and Subsidies

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