Debt and Taxes? The Effect of TCJA Interest Limitations on Capital Structure

Abstract

The Tax Cuts & Jobs Act of 2017 (TCJA) placed limitations on the deductibility of interest for U.S. firms. Using a difference-in-differences design examining both affected and unaffected firms, we show that following the enactment of the new limitations, affected firms significantly decrease corporate leverage. Specifically, we find that relative to unaffected U.S. firms, affected firms experience a decrease in leverage of 2.9% of assets; corresponding to about $126 million per firm and $29.8 billion aggregated over our full sample. This represents a debt decrease of 5.8% relative to the average debt to asset ratio for the pre-TCJA affected sample. We find similar results using a triple differences design, which benchmarks debt trends in the U.S. to those of unaffected and pseudo-affected Canadian firms that would be subject to the limitation had they been U.S. firms. These results are driven by decreases in long-term domestic debt and by declines in new issuances rather than repayment of existing debt. Robustness tests indicate other elements of tax reform do not influence the results. We also find firms not currently subject to limitations on interest but subject to future limitations decrease leverage by about half as much as firms currently subject to interest limits.

Keywords: TCJA, tax reform, interest limitation, capital structure, debt, leverage

JEL Classification: H26, H71, H72