When Donald Trump signed the 2017 Tax Cuts and Jobs Act (TCJA), it seemed like a huge win for corporations. The new law slashed the corporate tax rate from as high as 39 percent to a flat 21 percent.
But beneath that business-friendly benefit lurked some less-favorable changes to how companies calculate their tax burden, including a limit on the amount of debt interest that companies could write off.
Since this limit reduces one of the tax benefits of loans, it should, in theory, discourage companies from taking on more debt. Yet in reality, this change in the tax law did little to alter companies’ borrowing habits.
In fact, as past research has shown, “tax-related changes seem to matter very little in explaining corporations’ borrowing behavior,” says Matthew Phillips, an assistant professor of accounting information and management at Kellogg.
Phillips collaborated with Edward Maydew at the University of North Carolina at Chapel Hill and Zirui Song at MIT to investigate the reasons behind this disconnect between tax policy and real-world practice.
They found that the new rules didn’t really budge the massive U.S. debt market in part because a lot of players—from lenders to asset managers who buy loans on the secondary market—likely had money in their coffers that they didn’t want sitting idle. And so, they were willing to absorb a large chunk of the costs introduced by the TCJA so that companies wouldn’t shy away from taking on more debt.
“There’s a lot of lenders in that space that have dry powder and have a need to place capital,” Phillips says. “Even changing tax policy isn’t going to make all that money evaporate overnight.”
Levers to control debt
Large companies tend to amass huge amounts of debt to finance their operations and to help them scale. But if many of these firms can’t repay their loans, their financial distress could send shudders throughout the whole economy—especially during an economic downturn.
“If you think about just one company taking on more leverage than would otherwise be appropriate, that’s not such a big deal,” Phillips says.
But if the problem is widespread, then during a downturn, “you start to see high default rates,” he adds. “That puts a strain on banks’ ability to lend, and things start to go down from there.”
One lever that policymakers can use to address this concern is to adjust tax law and make it less attractive for firms to accumulate so much debt. Phillips doesn’t know whether the architects of the TCJA had this goal in mind. But under the new law, firms were restricted to deducting only up to 30 percent of their adjusted taxable income.
Additional changes to the tax rate and how companies could use losses to offset past profits also essentially reduced firms’ ability to deduct interest even further.
But even with all these changes, corporate borrowing went largely unabated after the law went into effect. In fact, by one measure, lending steadily increased from about $4.25 trillion in 2017 to about $6.5 trillion in 2024. This motivated Phillips and his colleagues to dig into the mechanics of why debt remained so resilient in the face of less-favorable tax treatment.
Big, risky loans
For their study, the researchers focused on syndicated loans—a $4 trillion market that includes “some of the biggest and riskiest loans,” Phillips says, “which is why we think this is the most important setting to test this.”
To understand syndicated loans, imagine that a company wants to borrow a huge amount of money. “If General Motors wants a loan, they’re not just going to go to Bank of America, and Bank of America gives them $10 billion,” he says. Since most banks wouldn’t want to take on the risk of lending the full amount alone, they coordinate with multiple lenders instead, each of which contributes, say, $1 billion.
The researchers analyzed 3,625 syndicated loans to 1,267 public companies from 2014 to 2023 (excluding 2020 to 2021 due to emergency changes during the Covid-19 pandemic).
They started by identifying companies that had interest expenses they could not deduct—or excess interest. These firms were generally riskier and thus had to pay higher interest rates than other companies. In other words, lenders charged them a premium.
This was true both before and after the TCJA. But after the new tax law took effect, that premium shrank. While the riskier firms still had to pay higher interest rates than other companies, they weren’t penalized as much as they were before.
The analysis suggests that these companies responded to the policy changes not by reducing their debt, but by negotiating more-favorable terms for the loans. To be specific, the companies counteracted higher costs under the TCJA by asking lenders for lower interest rates.
“The borrower might say, ‘Hey, we had this shift. We don’t want to eat the entirety of the higher after-tax cost,’” Phillips says. “‘Can you guys take on a piece as well?’”
His team estimated that the lenders took on about 36 to 42 percent of the increased cost after the TCJA. In addition, the lenders didn’t appear to insist on stricter loan terms, such as more-stringent firm-performance requirements in exchange for lowering their rates.
A supply and demand dance
But why would lenders agree to this arrangement? The research points to various forces at play in the market.
For one, banks and nonbank lenders had money on hand that they wanted to lend out.
Second, asset managers at other institutions often raise money from investors, buy hundreds of syndicated loans from the original lenders, and bundle the loans into vehicles called collateralized loan obligations (CLOs). As borrowers make interest and principal payments, the CLO investors receive the proceeds. Since CLOs can only contain syndicated loans, these vehicles drive more demand for this type of debt.
“These are the types of things that are going to be countervailing market forces to something like an interest-deductibility limitation, because you can’t just return all this money back to investors,” Phillips says. “They need to find syndicated loans to buy.”
In line with previous studies, the researchers didn’t see a decrease in the amounts of individual companies’ loans or the total amount of debt they amassed after the TCJA. “Overall leverage isn’t changing,” he says.
The big-picture takeaway for policymakers is that, at least in this part of the loan market, they can’t expect to reduce debt only by weakening companies’ incentive to borrow. They likely need to reduce lenders’ ability or desire to provide money as well.
“The negotiating dynamics are changing,” Phillips says. “When you enact a policy that’s meant to discourage borrowing, it doesn’t necessarily discourage the lending.” To bring down debt levels, “you would want to think about the supply side, too.”