The Impact of Federal Taxes on the Use of Debt by Closely-Held Corporations
Special Academic Paper
Executive Summary It is often asserted that the income tax encourages the use of debt because of the deductibility of interest expense. We examine this conjecture by analyzing the interest incurred by a large sample of closely-held corporations. We estimate regressions of the level of interest on the estimated marginal tax rate, the level of non-debt tax shields, a term reflecting the interaction of tax rates with non-debt tax shields, and other determinants of leverage. The evidence is consistent with the assertion that the tax benefits associated with interest expense encourage firms to use debt. We also find evidence that the extent to which tax rates influence firms to incur interest expense depends significantly on the availability of other non-debt tax shields.