 Taxation and the Optimal Constraint on Corporate Debt FinancePeter Birch Sørensen No 5101, CESifo Working Paper Series from CESifo Abstract: The tax bias in favour of debt finance under the corporate income tax means that corporate debt ratios exceed the socially optimal level. This creates a rationale for thin-capitalization rules limiting the amount of debt that qualifies for interest deductibility. This paper sets up a model of corporate finance and investment in a small open economy to quantify the deadweight loss from the asymmetric tax treatment of debt and equity and to identify the second-best optimal debt-asset ratio in the corporate sector. For plausible parameter values derived from data for the Norwegian economy, the deadweight loss from the tax distortions to corporate financing decisions amounts to 2-3 percent of total corporate tax revenue, and the socially optimal debt-asset ratio is 4-5 percentage points below the debt level currently observed. Driving the actual debt ratio down to this level would generate a total welfare gain of about 3 percent of corporate tax revenue. The welfare gain would arise partly from a fall in the social risks associated with corporate investment, and partly from the cut in the corporate tax rate made possible by a broader corporate tax base. Keywords: thin capitalization rules; tax bias against equity finance (search for similar items in EconPapers) Downloads: (external link) Related works: Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text Persistent link: https://EconPapers.repec.org/RePEc:ces:ceswps:_5101 Access Statistics for this paper More papers in CESifo Working Paper Series from CESifo Contact information at EDIRC. |
Is your work missing from RePEc? Here is how to contribute.
Questions or problems? Check the EconPapers FAQ or send mail to .
EconPapers is hosted by the
School of Business at Örebro University.