Debt and Taxes: a New Measure for Non-Debt Tax Shields

Debt and Taxes: a New Measure for Non-Debt Tax Shields

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  • Date Submitted: 11/13/2013 4:00 AM
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Debt and Taxes: A New Measure for Non-debt Tax Shields
James Schallheima
and
Kyle Wellsa,b
a. David Eccles School of Business
University of Utah
Salt Lake City, UT 84112-9303
b. Anderson Schools of Management
University of New Mexico
Albuquerque, NM 87131-0001
This Draft
February 2006
“You can’t underestimate how many of America’s greatest minds are being devoted to what
economist would all say is totally useless economic activity.”
- Peter Cobb, former Deputy Chief of Staff of the Joint Committee on Taxation
_________________________________________________
* Email address for the authors are finjs@business.utah.edu and wells@business.utah.edu. We thank John
Graham for providing access to his data and for his helpful comments and Craig Lewis, Mike Lemmon, Ryan
Whitby and seminar participants at University of New Mexico, Penn State University, University of South
Florida, and University of Virginia for helpful suggestions. We are responsible for all remaining errors
Debt and Taxes: A New Measure for Non-debt Tax Shields
ABSTRACT
Theory predicts that non-debt tax shields (NDTS) substitute for debt tax shields leading to a
negative relation between the two. Empirical research in this area, however, has failed to
provide robust support for the theory. We propose a new and simple proxy for NDTS called
the tax spread -- the difference between tax expense and taxes paid. We find statistically
significant determinants of the tax spread using accounting proxies for tax shielding activities.
We then compare the tax spread to Graham (2000) measure of under-leverage -- called kink.
We find a significant and positive relation between kink and the tax spread, inferring that firms
are finding alternatives to debt to reduce taxable income. Tax spread is then used as a
replacement for previous proxies of non-debt tax shields in extant empirical capital structure
models and provides results consistent with capital structure theory. Although our...

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