When Tax Shields Shrink: Interest Deductibility Limitations and Corporate Innovation

We investigate how limiting interest deductibility under the 2017 TCJA shapes corporate innovation. Using alternative identification strategies, we show that, relative to unaffected firms, affected firms experience significant declines in patenting and narrow the technological scope of their patent portfolios. This contraction is concentrated in exploitative patents, the type of innovation most naturally supported by debt financing. By weakening firms’ ability to finance innovation with long-term debt, interest limitations reveal a novel channel linking taxation to innovation, with the debt tax shield serving as an implicit subsidy. Cross-country evidence from the staggered implementation of interest limitation rules confirms negative effects.