Tax and leverage: Evidence from China

Kebin Deng, Yushu Zhu, Tom Smith, Alan McCrystal

Research output: Contribution to journalArticlepeer-review

10 Citations (Scopus)


This study exploits two institutional features of China to test the causal link between tax and capital structure. First, the central government exclusively determines the corporate tax rate in China, which results in changes in corporate income tax rates across different Chinese public firms over the period of 2000–2011. Such mandatory tax shifts provide a quasi-natural experimental setting for our difference-in-differences analysis investigating the impact of tax on leverage. We find evidence supporting the dynamic trade-off theory, namely that firms are unresponsive to tax cuts but increase long-term leverage when taxes rise (particularly those in low statutory tax regimes). Second, governmental intervention in capital allocation is common in China such that political connections are usually regarded as an asset for firms in accessing bank loans. Using anti-corruption events as shocks to the value of political connections over the sample period, our research is the first study to show that political connections become a liability that enables banks to recall loans from affected firms during the anti-corruption campaign periods. This change overturns the typical tax-leverage relationship observed, as we find anti-corruption affected firms reduce long-term leverage when taxes are cut and they become insensitive to tax increases. Our results reveal the importance of political ties in explaining how firms adjust their capital structure to tax changes, which is extremely relevant to policy makers and regulators when monitoring bank loan markets.
Original languageEnglish
Article number101479
Pages (from-to)1-20
Number of pages20
JournalChina Economic Review
Early online date13 May 2020
Publication statusPublished - 1 Aug 2020


  • Bank loan
  • Capital structure
  • China's tax system
  • Political connection
  • Tax–leverage relationship


Dive into the research topics of 'Tax and leverage: Evidence from China'. Together they form a unique fingerprint.

Cite this