How effective is an incremental ACE in addressing the debt bias? Evidence from corporate tax returns
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How effective is an incremental ACE in addressing the debt bias? Evidence from corporate tax returns Nicola Branzoli1 · Antonella Caiumi2
© Springer Science+Business Media, LLC, part of Springer Nature 2020
Abstract The Allowance for Corporate Equity (ACE) introduced in Italy in 2011 has decreased the fiscal distortion between the costs of equity and debt by introducing the deductibility from taxable income of a notional return on capital increases. In this paper, we estimate the impact of the ACE on the leverage ratio of Italian manufacturing firms. Using a novel instrumental variable approach to identify the causal effect, we find that the introduction of the incremental ACE has substantially reduced the leverage ratio of its beneficiaries. We find that the effect is larger for smaller enterprises and for mature firms. In addition, the impact of the ACE is higher for vulnerable and risky firms than for sound firms. These results suggest that an incremental ACE may be an effective policy tool to reduce the leverage ratio of European firms. Keywords Allowance for Corporate Equity · Corporate leverage · Debt–equity bias JEL Classification G32 · H25 · H32
1 Introduction The deductibility of interest expenses from taxable income makes, ceteris paribus, debt cheaper than equity for firms. Numerous empirical studies (Rajan and Zingales 1995; Graham 2008) have shown that fiscal incentives influence the choice of financial leverage and, in particular, that the deductibility of interest expenses increases firms’ leverage (Heidera and Ljungqvist 2015; Alberternst and Sureth-Sloane 2015). * Nicola Branzoli [email protected] Antonella Caiumi [email protected] 1
Bank of Italy, Rome, Italy
2
National Institute of Statistics, Rome, Italy
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N. Branzoli, A. Caiumi
Fiscal distortions of firms’ capital structure have gained considerable attention in recent years because, through their effect on leverage, they can have an impact on the stability of the financial sector. Leverage increases firms’ default rate during economic downturns (Molina 2005; Carlinga et al. 2007; Bonfim 2009; Löffler and Maurer 2011) and, thus, can amplify the consequences of economic slowdowns by worsening banks’ balance sheet (Sutherland and Hoeller 2012). In this context, the Allowance for Corporate Equity (ACE, also called Notional Interest), originally proposed in 1991 by the Institute for Fiscal Studies (Institute for Fiscal Studies 1991; Devereux and Freeman 1991), has attracted renewed attention, and it has been quite widely advocated as the best available solution toward a more neutral tax system (Mirrlees et al. 2011; de Mooij 2011; Mooij and Devereux 2011; Devereux and Vella 2014; Clausing et al. 2016). ACE favors the rebalancing of the financial structure of firms by allowing both the deductibility of actual debt financing costs and a notional deduction for equity financing costs. The European Commission proposal for a Consolidated Common Corporate Tax Base (CCCTB) includes a notional interest deduct
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