Financial leverage and corporate taxation: evidence from German corporate tax return data
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To estimate the impact of profit taxation on the financial leverage of corporations, this study uses a pseudopanel constructed from comprehensive corporate tax return microdata for the period 1998–2001, which saw the introduction of major corporate tax reform in Germany. Financial leverage refers to the ratio of long-term debt to total capital. The endogeneity of the firm-specific marginal after-financing corporate income tax rate is controlled for by an instrumental variable approach. The instrument for the observed marginal tax rate is the counterfactual tax rate that a corporation would have faced in a particular period had there been no endogenous change, triggered by the tax reform, of its financial leverage and tax base. This counterfactual tax rate is derived from a detailed microsimulation model of the corporate sector, based on tax return microdata. The marginal tax rate has a statistically significant and relatively large positive effect on corporate leverage; for firms reporting positive profits, an increase of the marginal tax rate of 1 % would increase the financial leverage by approximately 0.7 %, on average. The debt ratio is less responsive to tax incentives for small corporations and firms facing high economic risks.
KeywordsFinancial structure Debt ratio Corporate income taxation Corporate tax return data Microsimulation
JEL ClassificationH25 H32 G32 G38
We would like to thank Dhammika Dharmapala and two anonymous referees for very helpful comments on a previous version of this paper. We also thank Martin Simmler, Florian Walch, and seminar participants at the Free University Berlin, the Max-Planck Institute for Tax Law and Public Finance Munich, and the European Meeting of the Econometric Society for helpful comments on an early draft of this article. We are grateful to David Houser for copyediting the paper. This paper is part of a research project supported by the Federal Ministry of Finance. Results and opinions expressed in this paper are those of the authors and do not necessarily reflect views of the Federal Ministry of Finance or DIW Berlin.
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