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Taxes Depress Corporate Borrowing: Evidence from Private Firms

Ivan Ivanov¹; Luke Pettit²; Toni M. Whited³

¹ Federal Reserve Bank of Chicago · ² George Mason University · ³ University of Michigan and NBER

We use variation in state corporate income tax rates to re-examine the relation between taxes and corporate leverage. Contrary to prior research, corporate leverage rises after tax cuts for small private firms. An estimated dynamic equilibrium model shows that tax cuts make capital more productive and spur the use of leverage. Tax cuts also produce more distant default thresholds and lower credit spreads. These effects outweigh the lower interest tax deduction and lead to higher optimal leverage choices, especially for firms with flexible investment policies. The presence of the interest tax deduction raises consumer welfare in equilibrium.

DOI

10.1093/restud/rdaf094

Volume

93 (4)

Pages

2715-2749

Language

en

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