Debt and Taxes? The Effect of Tax Cuts & Jobs Act of 2017 Interest Limitations on Capital Structure

ABSTRACT The Tax Cuts & Jobs Act of 2017 (TCJA) limited interest deductibility. Using a difference-in-differences design, we show that following the enactment of the new limitations, affected firms significantly decrease their leverage. Specifically, we find that relative to unaffected U.S. firms, affected firms decrease leverage by 7.6 percent of assets, corresponding to $330 million per firm and $84.8 billion for the treatment sample. These results are driven by decreases in long-term domestic debt and by declines in new issuances rather than debt repayment. Additional tests indicate other tax reform elements do not explain the results. We also find that 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 the limits. Overall, our findings document an economically significant effect of recent tax reform on firm behavior and advance understanding of how taxes affect capital structure. JEL Classifications: H26; H71; H72.