Do taxes affect corporate debt policy? Evidence from US corporate tax return data

This paper uses U.S. Statistics of Income (SOI) Corporate Income Tax Returns balance sheet data on all corporations, to estimate the effects of changes in corporate tax rates on the debt policies of firms of different sizes. Small firms face very different tax rates than larger firms, and relative tax rates have also changed frequently over time, providing substantial information to identify tax effects. The results suggest that taxes have had a strong and statistically significant effect on debt levels. For example, cutting the corporate tax rate by ten percentage points (e.g. from 46 to 36%), holding personal tax rates fixed, is forecast to reduce the fraction of assets financed with debt by around 3.5%. Since small firms normally rely much more heavily on debt finance yet face much lower tax incentives to use debt, the estimated effect of taxes would be strongly biased downwards without controls for firm size. (C) 2001 Elsevier Science BY All rights reserved.