As Certain as Debt and Taxes: Estimating the Tax Sensitivity of Leverage from Exogenous State Tax Changes

Florian Heider, Alexander Ljungqvist

NBER Working Paper No. 18263
Issued in July 2012
NBER Program(s):   CF

We use a natural experiment in the form of 121 staggered changes in corporate income tax rates across U.S. states to show that tax considerations are a first-order determinant of firms' capital structure choices. Over the period 1990-2011, firms increase long-term leverage by 104 basis points on average (or $32.5 million in extra debt) in response to an average tax increase of 131 basis points. Contrary to static trade-off theory, the tax sensitivity of leverage is asymmetric: firms do not reduce leverage in response to tax cuts. Using treatment reversals, we find this to be true even within-firm: tax increases that are later reversed nonetheless lead to permanent increases in a firm's leverage - an unexpected and novel form of hysteresis. Our findings are robust to various confounds such as unobserved variation in local business conditions, union power, or unemployment risk. Treatment effects are heterogeneous and confirm the tax channel: tax sensitivity is greater among profitable and investment-grade firms which respectively have a greater marginal tax benefit and lower marginal cost of issuing debt.

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This paper was revised on April 15, 2014

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Document Object Identifier (DOI): 10.3386/w18263

Published: As Certain as Debt and Taxes: Estimating the Tax Sensitivity of Leverage from State Tax Changes, Florian Heider, Alexander Ljungqvist. in New Perspectives on Corporate Capital Structure, Acharya, Almeida, and Baker. 2015

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