How Does Removing the Tax Benefits of Debt Affect Firms? Evidence from the 2017 U.S. Tax Reform

Ali Sanati; Mehdi Beyhaghi

doi:10.1093/rfs/hhaf041

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How Does Removing the Tax Benefits of Debt Affect Firms? Evidence from the 2017 U.S. Tax Reform

Ali Sanati¹; Mehdi Beyhaghi²

¹ American University Kogod School of Business · ² Federal Reserve Board

Review of Financial Studies 2025

The impact of tax benefits of debt on firms remains an open question. The 2017 U.S. tax reform limited the tax advantage of debt for all firms except for small businesses with average sales below $25 million. A regression discontinuity design based on the exception threshold shows that, as tax benefits of debt shrink, corporate debt declines significantly, while equity does not increase sufficiently to offset the reduction. Treated firms also decrease their investments due to the higher cost of capital. Overall, we document a first-order role for tax incentives that affect the cost of capital in shaping corporate policies. (JEL G31, G32, G38, H25, K34)

DOI: 10.1093/rfs/hhaf041
Language: en
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