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Ruud A. de Mooij

Front Matter Page Fiscal Affairs Department Authorized for distribution by Victoria Perry Contents Abstract I. Introduction II. Empirical Studies on Debt Bias A. Variation in Non-debt Tax Shields B. Marginal Tax Rates and Incremental Debt C. Marginal Tax Rates and Debt Levels D. Cross-country Studies III. Constructing a Meta Sample A. Tax Elasticities of Debt B. Variation in Study Characteristics IV. Meta Analysis A. Methodology B. Meta Regressions C. Simulated Tax Elasticities V. Conclusions Tables 1

Ruud A. de Mooij
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.
Ruud A. de Mooij

to identify tax effects. Subsequent literature has come up with four solutions to better identify tax effects. Each of these types is discussed below. A. Variation in Non-debt Tax Shields One way out of the lack of variation in tax rates, suggested by DeAngelo and Masulis (1980) , is to use variation in non-debt corporate tax shields, such as depreciation allowances and tax losses that are carried forward. These tax shields may reduce the value of the interest deduction, as taxable profits can become negative. Non-debt tax shields thus substitute for debt

Mr. Reint Gropp

credits, accelerated depreciation allowances, or tax loss carryforwards face lower effective corporate tax rates than an identical firm without these nondebt tax shields. A large number of studies attempt to empirically establish the relationship between nondebt tax shields and financing choices of firms. Titman and Wessels (1988) , Bradley, Jarrell, and Kim (1984) among others, fail to find significant tax effects. MacKie-Mason (1990a) shows that it is important to consider incremental financing decisions, rather than aggregate debt-equity ratios. If effective

Ms. Grace Weishi Gu, Ruud A. de Mooij, and Mr. Tigran Poghosyan

this for banks, however. We use the proportion of total security assets and non-earning assets out of total assets as a proxy for collateral. Finally, DeAngelo and Masulis (1980) show that non-debt tax shields are a substitute for the tax benefits of debt financing. Hence, they should be negatively related to leverage. We measure non-debt tax shields by total non-interest expenses to total assets ratio. We also control for subsidiary host country determinants. First, we include GDP growth and inflation. High growth at the country level is expected to facilitate

Jennifer Blouin, Harry Huizinga, Mr. Luc Laeven, and Gaetan Nicodeme

subsidiaries easily through international debt shifting ( Desai, Foley, and Hines, 2004 ; Huizinga, Laeven, Nicodème, 2008 ). This suggests that quantitative restrictions on foreign affiliates in the form of thin capitalization rules can be an important determinant of foreign affiliate leverage. However, studies of capital structure in the corporate finance literature typically capture tax advantages of debt exclusively using information on tax rates, without consideration of other differences in tax codes that constrain leverage and thus the value of tax shields (see, for