The Effect of the Corporate Income Tax on Leverage in Public Corporations

Abstract

This paper explores the question of how corporate income taxation affects corporate debt. New measures of first- and last-dollar corporate marginal tax rates compiled from the SOI corporate tax database using the Treasury corporate tax model reflect the full complexity of the US corporate tax code. Use of a merged panel of SOI and Compustat data for a sample of 1036 publicly owned corporations enables accurate measurement of both financial and tax variables influencing the corporate leverage decision. In contrast to recent studies, this report finds a negative relationship between corporate debt levels and marginal tax rates. However, it finds a positive relationship between changes in corporate debt levels and lagged marginal tax rates. Instrumentation for endogenous last-dollar tax rates with exogenous first-dollar tax rates indicates that corporate debt is likely more sensitive to marginal tax rates at the last-dollar margin than for lower levels of debt.