How Will the TCJA of 2017 Change the Tax Benefits of Debt? – The Unintended Industry Effect of the Cap on Interest Expense

Using a production-based structural model, calibrated with data for the period 2001-2017, we find that the cap on the deduction of interest expense enshrined in the Tax Cuts and Jobs Act of 2017 reduces the net tax benefits of debt differentially across industries by 1% to 2.2% of un-levered firm-value on average. The new tax provisions make firms' current capital structure policies considerably less conservative - a typical firm can double its existing interest burden compared to increasing it more than six-fold earlier, before marginal net tax benefits decline; the impact is larger for capital intensive industries that employ more leverage. A change in the mix of factor inputs, that depends on technology flexibility in that industry, can preserve a part of the tax benefits in some industries. Collectively our results show that the well documented positive relationship between firm leverage and physical capital employed will decline on average