07-09-2026
For policymakers, setting the optimal corporate tax rate requires balancing two important priorities: raising revenue to fund public services and infrastructure while avoiding a tax burden that could discourage growth, investment or job creation. Business leaders may understandably argue that higher corporate taxes strain company finances, but the relationship between tax policy and financial distress depends on how companies absorb and respond to those costs.
In their research, Mara Faccio, the Daniels School’s Tom and Patty Hefner Chair in Finance, and coauthor Stefano Manfredonia investigate the relationship between corporate taxes and financial distress. Their paper titled “Taxes and Financial Distress: Evidence from Establishment-Level Data” is part of the National Bureau of Economic Research (NBER) Working Paper Series.
Faccio and Manfredonia’s findings point to several practical takeaways for understanding how corporate tax changes impact a company’s financial stability.
Faccio and Manfredonia use the Paydex score, a measure of how promptly an establishment pays its bills, to quantify financial distress. The researchers use a unique combination of establishment- and firm-level data, factoring in a company’s geographic footprint to examine how state corporate tax changes affect firms across their different locations.
They find that higher corporate income tax rates increase the financial distress of affected establishments of publicly traded companies, and the impact depends on the location and combined tax exposure of all a firm’s establishments. These effects are substantially larger for companies with a high concentration of locations in states hiking corporate income tax rates.
State-level tax changes can ripple across an organization. For companies operating in multiple states, financial pressure in one part of the business can spread internally and create strain across other locations.
Higher corporate income tax rates increase financial distress through two main channels:
Separating the effects of these two channels is the real challenge. “They are very difficult to disentangle when focusing on tax rate changes, because tax rate changes predict that both effects can operate and they will both increase financial distress,” says Faccio.
In their paper, Faccio and Manfredonia use the introduction of the Tax Cuts and Jobs Act (TCJA) in 2017 to determine whether the cash-flow or tax-shield channel dominates.
In addition to lowering the federal corporate tax rate, the TCJA introduced a new limit that changed the tax incentives associated with debt financing. Starting in 2018, companies could only deduct net interest expenses up to 30% of their adjusted taxable income.
The cash-flow channel predicts that affected companies will have less cash after taxes because they lose some tax benefits from borrowing, which could increase financial distress. In contrast, the tax-shield channel predicts that reducing the tax incentive to borrow will cause companies to reduce debt levels, leading to less financial distress.
The researchers find that companies affected by this limit experience a significant relative reduction in financial distress, suggesting that the positive effect of lower debt levels outweighs the negative effect of reduced after-tax cash flow. While the TCJA was designed to spur growth by cutting corporate taxes, its limit on interest deductions may have further contributed to improved financial stability.
According to Faccio, the results on tax rate changes “indicate that state-level tax policy has consequences for default risk that extend beyond a state’s jurisdiction and affect other states.” Future research may provide even more insight. “Naturally,” says Faccio, “investigating the impact of these policies on other outcomes, including investment and innovation (on which we will have a separate paper), will be crucial for saying something more general about the implications for business leaders.”
