Tax loss carryforwards and corporate behavior

Tax losses are prevalent in the corporate sector of many countries. Firms with tax losses can deduct these losses from current or future taxable income. This deduction reduces corporate marginal tax rates and in turn can affect managerial incentives. Using industry-year level tax return data and accounting data, we show that tax loss carryforwards decrease leverage. We also show that tax loss carryforwards increase investments when the effective tax rates among the industry-year observations are considerably affected by tax loss carryforwards. Our findings suggest that the incentive effects of tax loss carryforwards on corporate behavior need to be considered in tax reforms in addition to other factors in public finance.