Working Paper: NBER ID: w21834
Authors: Alexander Ljungqvist; Liandong Zhang; Luo Zuo
Abstract: Using 113 staggered changes in corporate income tax rates across U.S. states, we provide evidence on how taxes affect corporate risk-taking decisions. Higher taxes reduce expected profits more for risky projects than for safe ones, as the government shares in a firm’s upside but not in its downside. Consistent with this prediction, we find that risk taking is sensitive to taxes, albeit asymmetrically: the average firm reduces risk in response to a tax increase (primarily by changing its operating cycle and reducing R&D risk) but does not respond to a tax cut. We trace the asymmetry back to constraints on risk taking imposed by creditors. Finally, tax loss-offset rules moderate firms’ sensitivity to taxes by allowing firms to partly share downside risk with the government.
Keywords: taxes; corporate risk taking; income tax; differences-in-differences
JEL Codes: G32; H32
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Tax increases (H29) | Decrease in risk-taking behavior (D91) |
| Tax increases (H29) | Decrease in expected profits for risky projects (D81) |
| Tax cuts (H29) | No significant increase in risk-taking behavior (G40) |
| Tax cuts (H29) | Increase in risk for low-leverage firms (G32) |
| Tax loss offset rules (H21) | Moderate firms' sensitivity to taxes (H32) |