Although the empirical literature has long struggled to identify the impact of taxes on corporate financial structure, a recent boom in studies offers ample support for the debt bias of taxation. Yet, studies differ considerably in effect size and reveal an equally large variety in methodologies and specifications. This paper sheds light on this variation and assesses the systematic impact on the size of the effects. We find that, typically, a one percentage point higher tax rate increases the debt-asset ratio by between 0.17 and 0.28. Responses are increasing over time, which suggests that debt bias distortions have become more important.

Tax provisions favoring corporate debt over equity finance (“debt bias”) are widely recognized as a risk to financial stability. This paper explores whether and how thin-capitalization rules, which restrict interest deductibility beyond a certain amount, affect corporate debt ratios and mitigate financial stability risk. We find that rules targeted at related party borrowing (the majority of today’s rules) have no significant impact on debt bias—which relates to third-party borrowing. Also, these rules have no effect on broader indicators of firm financial distress. Rules applying to all debt, in contrast, turn out to be effective: the presence of such a rule reduces the debt-asset ratio in an average company by 5 percentage points; and they reduce the probability for a firm to be in financial distress by 5 percent. Debt ratios are found to be more responsive to thin capitalization rules in industries characterized by a high share of tangible assets.

This paper investigates the role of tax incentives towards debt finance in the buildup of leverage in the nonfinancial corporate (NFC) sector, using a large firm-level dataset. We find that so-called debt bias is a significant driver of leverage, for both small and medium-sized enterprises and larger firms, with its effect accounting for about a quarter of leverage. The strength of this effect differs with firm size, the availability of collateral, income and income volatility, cash flow, and capital intensity. We conclude that leveling the playing field between debt and equity finance through tax policy reform would decrease NFC leverage, reducing economic risks posited by leverage.

Risks to macroeconomic stability posed by excessive private leverage are significantly amplified by tax distortions. ‘Debt bias’ (tax provisions favoring finance by debt rather than equity) has increased leverage in both the household and corporate sectors, and is now widely recognized as a significant macroeconomic concern. This paper presents new evidence of the extent of debt bias, including estimates for banks and non-bank financial institutions both before and after the global financial crisis. It presents policy options to alleviate debt bias, and assesses their effectiveness. The paper finds that thin capitalization rules restricting interest deductibility have only partially been able to address debt bias, but that an allowance for corporate equity has generally proved effective. The paper concludes that debt bias should feature prominently in countries’ tax reform plans in the coming years.

Tax distortions are likely to have encouraged excessive leveraging and other financial market problems evident in the crisis. These effects have been little explored, but are potentially macro-relevant. Taxation can result, for example, in a net subsidy to borrowing of hundreds of basis points, raising debt-equity ratios and vulnerabilities from capital inflows. This paper reviews key channels by which tax distortions can significantly affect financial markets, drawing implications for tax design once the crisis has passed.

Although the empirical literature has long struggled to identify the impact of taxes on corporate financial structure, a recent boom in studies offers ample support for the debt bias of taxation. Yet, studies differ considerably in effect size and reveal an equally large variety in methodologies and specifications. This paper sheds light on this variation and assesses the systematic impact on the size of the effects. We find that, typically, a one percentage point higher tax rate increases the debt-asset ratio by between 0.17 and 0.28. Responses are increasing over time, which suggests that debt bias distortions have become more important.

This paper reviews the rapidly growing empirical literature on international tax avoidance by multinational corporations. It surveys evidence on main channels of corporate tax avoidance including transfer mispricing, international debt shifting, treaty shopping, tax deferral and corporate inversions. Moreover, it performs a meta analysis of the extensive literature that estimates the overall size of profit shifting. We find that the literature suggests that, on average, a 1 percentage-point lower corporate tax rate will expand before-tax income by 1 percent—an effect that is larger than reported as the consensus estimate in previous surveys and tends to be increasing over time. The literature on tax avoidance still has several unresolved puzzles and blind spots that require further research.

Most tax systems create a tax bias toward debt finance. Such debt bias increases leverage and may negatively affect financial stability. This paper models and estimates debt bias in the financial sector, and present novel estimates for investment banks and non-bank financial intermediaries such as finance and insurance companies. We find debt bias to be pervasive, explaining as much as 10 percent of total leverage for regular banks and 20 percent for investment banks, with the effects most pronounced before the global financial crisis. Going forward, debt bias is likely to once again gain prominence as a key driver of leverage decisions, underscoring the importance of policy reform at this juncture.

This book was first published in 2007. Most countries levy taxes on corporations, but the impact - and therefore the wisdom - of such taxes is highly controversial among economists. Does the burden of these taxes fall on wealthy shareowners, or is it passed along to those who work for, or buy the products of, corporations? Can a country with high corporate taxes remain competitive in the global economy? This book features research by leading economists and accountants that sheds light on these and related questions, including how taxes affect corporate dividend policy, stock market value, avoidance, and evasion. The studies promise to inform both future tax policy and regulatory policy, especially in light of the Sarbanes-Oxley Act and other actions by the Securities and Exchange Commission that are having profound effects on the market for tax planning and auditing in the wake of the well-publicized accounting scandals in Enron and WorldCom.

This paper explores how corporate taxes affect the financial structure of multinational banks. Guided by a simple theory of optimal capital structure it tests (i) whether corporate taxes induce subsidiary banks to raise their debt-asset ratio in light of the traditional debt bias; and (ii) whether international corporate tax differentials vis-a-vis foreign subsidiary banks affect the intra-bank capital structure through international debt shifting. Using a novel subsidiary-level dataset for 558 commercial bank subsidiaries of the 86 largest multinational banks in the world, we find that taxes matter significantly, through both the traditional debt bias channel and the international debt shifting that is due to the international tax differentials. The latter channel is more robust and tends to be quantitatively more important. Our results imply that taxation causes significant international debt spillovers through multinational banks, which has potentially important implications for tax policy.