The Real and Financial Effects of Local Corporate Tax Increases: Evidence from Linked Firm–Bank Data

We study how local corporate tax increases affect firms’ financing and real activity. In Portugal, municipalities independently set a surtax on corporate income, generating plausibly exogenous variation across space and time. We link the universe of corporate balance sheets and profitand-loss statements to loan-level data from the Bank of Portugal’s credit registry, allowing us to track firms’ liquidity, leverage, borrowing costs, and credit quality alongside revenues, inputs, employment, and productivity. We estimate local-projection difference-in-differences models that address staggered treatment timing and dynamic responses. Surtax hikes immediately tighten financing conditions: liquidity falls, implicit interest rates rise, debt increases at shorter maturities, and non-performing loans become more prevalent. These strains spill over into real outcomes: firms reduce sales, inputs, and employment and experience persistent declines in total factor productivity. Effects are strongest among small and young firms, where leverage rises in response to liquidity losses, while larger firms increase leverage in line with tax-shield incentives. We also find higher exit and relocation probabilities, but no gains in neighboring output, pointing to inefficient reallocation. Our results highlight how local tax policy can transmit through both financial and real margins, with implications for fiscal design in decentralized settings.