Heterogeneous Responses to Corporate Marginal Tax Rates: Evidence from Small and Large Firms

How do small versus large firms respond to tax cuts? Using new narrative measures of exogenous variation in corporate marginal tax rates and a unique dataset from U.S. firms, we show that the investment response of large firms to a tax cut is almost twice the response of small firms. Furthermore, small firms finance their new investment almost entirely by debt, whereas large firms use cash and debt. Following the tax cut, the tax advantage of debt-financing falls relative to cash-financing. This substitution effect is more pronounced for unconstrained firms and contributes to the greater cash financing of large firms.