Should interest expenses be tax deductible?

Sigitas Karpavičius*, Fan Yu

*Corresponding author for this work

Research output: Contribution to journalArticle

2 Citations (Scopus)

Abstract

This paper analyzes how shareholder wealth, firm characteristics, and public finance would be impacted if tax deductibility of interest expenses were eliminated. We find that shareholder value would decrease by 3.5%. Under the new regime, firms would be smaller and less levered, would have less productive capital, and would feature lower default probabilities. The effects on aggregate output and employment would be negative. However, the government's revenues from corporate income tax would increase by 3% in the long-run and could be used to partially offset the negative side effects of the reform. The current period of historically low corporate bond yields is probably the best time to change the treatment of interest expenses.

Original languageEnglish
Pages (from-to)100-116
Number of pages17
JournalEconomic Modelling
Volume54
DOIs
Publication statusPublished - 1 Apr 2016

Keywords

  • Corporate income tax
  • Tax deductibility
  • Interest expenses

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