Economic Growth and the Debt Tax Shield

We study the general-equilibrium implications of the corporate debt tax shield in a growth economy that taxes household income and firm profits and redistributes tax revenues in anattempt to harmonize the lifetime consumption opportunities among households that differ in their endowments. Our model shows that in general equilibrium the tax shield’s reduction in the corporate after-tax borrowing rate is counteracted by an increase in the pre-tax rate. Our model further predicts the debt tax shield to lead to a higher growth rate of the economy and an increase in the degree of disparity in households’ lifetime consumption opportunities.