Taxes and the Efficiency Costs of Capital Distortions

Tax neutrality towards alternative financing instruments for corporate investment is a ubiquitous demand in the political debate. At the same time, the literature is surprisingly silent about the magnitude of possible efficiency costs of a departure from tax neutrality. Against this background, the present paper discusses the theory of capital structure and provides back- of-the-envelope calculations of the possible efficiency cost of a tax distortion of the debt- equity decision.

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