Taxes and Financial Distress: Evidence from Establishment-Level Data

We use establishment-level data to examine the relation between corporate taxes and financial distress. Using a border discontinuity design, we document that higher corporate income tax rates significantly increase financial distress, particularly for geographically concentrated firms, with sizable spillovers across establishments. We further investigate how taxes affect establishment-level financial distress by exploiting the interest limitation rule introduced by the 2017 Tax Cuts and Jobs Act. Using a difference-in-differences design, we find that affected firms experience a decline in financial distress. This occurs because the reduced tax advantage of debt induces firms to deleverage, reducing financial distress through capital structure adjustments.