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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.

Suggested Citation

  • Addessi, William & Saltari, Enrico, 2011. "The effect of debt tax benefits on firm investment decisions," MPRA Paper 35436, University Library of Munich, Germany.
    • Handle: RePEc:pra:mprapa:35436
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    References listed on IDEAS

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    1. Whited, Toni M, 1992. "Debt, Liquidity Constraints, and Corporate Investment: Evidence from Panel Data," Journal of Finance, American Finance Association, vol. 47(4), pages 1425-1460, September.
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    4. Kevin A. Hassett, 1999. "Tax Policy and Investment," Books, American Enterprise Institute, number 53049, September.
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    6. R. Glenn Hubbard, 1998. "Capital-Market Imperfections and Investment," Journal of Economic Literature, American Economic Association, vol. 36(1), pages 193-225, March.
    7. Saltari, Enrico & Ticchi, Davide, 2007. "Risk aversion, intertemporal substitution, and the aggregate investment-uncertainty relationship," Journal of Monetary Economics, Elsevier, vol. 54(3), pages 622-648, April.
    8. Gordon, Roger H. & Lee, Young, 2001. "Do taxes affect corporate debt policy? Evidence from U.S. corporate tax return data," Journal of Public Economics, Elsevier, vol. 82(2), pages 195-224, November.
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    Keywords

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    JEL classification:

    • D21 - Microeconomics - - Production and Organizations - - - Firm Behavior: Theory
    • G31 - Financial Economics - - Corporate Finance and Governance - - - Capital Budgeting; Fixed Investment and Inventory Studies
    • H32 - Public Economics - - Fiscal Policies and Behavior of Economic Agents - - - Firm

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