IHS Working Paper 32 - Taxes Depress Corporate Borrowing: Evidence from Private Firms

We read through the statutes to identify the relevant corporate income tax rate changes and record the respective enactment dates, typically the date the state’s governor signs the legislation. [...] We find that firm leverage increases in the enactment year, as well as in some of the subsequent years, indicating that the firm leverage changes prior to effective dates is driven by firms reacting promptly to the enactment of the tax legis- lation. [...] Third, we set the standard deviation of the tax rate equal to the standard deviation of the taxes observed in our sample (0.013), and we set average level of the tax rate equal to 0.2, following Nikolov and Whited (2014). [...] In addition, leverage is decreasing in the fixed cost, as are all of the policy-function sensitivities, as the presence of the fixed cost breaks the scaling properties of the model and decreases the correlations among all of the model variables. [...] Second, the spread between the prices corresponding to high and low taxes widens, reflecting the stronger effect of taxes on the default threshold than the value of the tax deduction.