Local Taxes and Capital Structure Choice

Posted: 24 May 2002

See all articles by Reint Gropp

Reint Gropp

Halle Institute for Economic Research

Abstract

This paper investigates the question of taxation and capital structure choice in Germany. Germany represents an excellent case study for investigating the question of whether and to what extent taxes influence the debt-equity decision of firms, because the relative tax burdens on debt and equity vary greatly across communities. German communities levy local taxes on profits and long-term debt payments in addition to personal and corporate taxes on the federal level. A stylized model is presented incorporating these taxes. The model shows that local taxes create substantial incentives for firms to use debt financing. Furthermore, the paper empirically investigates the effect of local business taxes on the share of debt used to finance incremental investments by German firms. I find that local taxes significantly influence the capital structure choice of firms, controlling for a large number of other factors. In an extensive sensitivity analysis the tax effect are found to be robust across several different specifications.

Keywords: Corporate taxation, capital structure choice, local taxes

JEL Classification: H25, H71, G32

Suggested Citation

Gropp, Reint, Local Taxes and Capital Structure Choice. Available at SSRN: https://ssrn.com/abstract=312788

Reint Gropp (Contact Author)

Halle Institute for Economic Research ( email )

P.O. Box 11 03 61
Kleine Maerkerstrasse 8
D-06017 Halle, 06108
Germany

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