The real and financial effects of local corporate tax increases: evidence from linked firm–bank data (European Central Bank)

Summary

• Net financial debt increases by about 7 percent on impact, while liquidity ratios decline by 0.3 percentage points on impact and 0.95 percentage points after four years.p.6
• Borrowing costs rise as implicit interest rates increase by 0.47 percentage points after one year, and short-term debt increases more sharply than long-term debt.p.6
• Credit quality deteriorates over time, resulting in a 1.4 percentage point higher share of firms with non-performing loans four years after a surtax hike.p.7
• Real activity contracts as employment drops by about 2 percent, total labor costs fall by 3 percent, and total factor productivity declines persistently by about 2.5 percent after three years.p.7
• Local tax increases elevate the probability of firm exit by 2.2 percentage points and firm relocation to lower-tax municipalities by 7.7 percentage points.p.7

Key insights

1. Local corporate tax hikes immediately create liquidity strains and increase short-term debt, driving up borrowing costs and eventually raising non-performing loan rates.p.2
2. The adverse financial effects of surtax increases are concentrated among small firms, which increase leverage to cover cash shortfalls rather than to utilize tax shields.p.7
3. Labor costs per worker drop following corporate tax hikes, demonstrating that workers absorb part of the local corporate tax burden.p.7
4. Firm relocations triggered by tax hikes increase the count of businesses in neighboring jurisdictions without producing measurable gains in aggregate output.p.7
5. Firms delay payments to suppliers via trade credit to manage liquidity shocks, effectively transmitting tax-induced financial stress upstream along supply chains.p.21
6. Multi-establishment firms are significantly more responsive to tax hikes on the relocation margin because having existing secondary locations lowers spatial adjustment costs.p.30