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Corporate taxes, leverage, and investment: evidence from Nazi-occupied Netherlands

Journal: Economic History Review

Date: 2024

Author: Philip T. Fliers, Abe de Jong, Bert Kramer

Abstract:
We examine the Netherlands around the Second World War, where the occupying Nazi regime overhauled the country's corporate tax regime and introduced a profit tax of 55 per cent. We estimate that the new tax regime cost investors at least 300 million guilders, an amount equivalent to 5 per cent of Dutch GDP in 1940. We demonstrate that the tax introduction changed the financing of Dutch businesses. In particular, we find strong evidence that debt financing increased because it provides a tax shelter. The changes in taxation also led to an after-tax reduction in the cost of debt, which had large real effects on firm investment. After the end of the war, firms with more leverage had higher capital expenditures.

Link: Google Scholar

Background and Context

Historical Setting

During WWII (1940-1945), Nazi Germany occupied the Netherlands and implemented major changes to corporate taxation, including introducing a 55% corporate tax rate.

Research Focus

The study examines how these tax changes affected Dutch firms' stock market valuations, financing decisions, and investment behaviors using data from 280 companies listed on the Amsterdam stock exchange.

Methodology

The analysis uses event studies around tax announcements, difference-in-differences analysis, and panel regression models to measure the impacts on firm value, leverage, and investment.

Significant Loss in Firm Value Following Tax Announcements

  • Stock prices dropped significantly following major tax announcements
  • First announcement in November 1940 led to -6.7% abnormal returns
  • Second announcement in May 1942 resulted in -3.3% abnormal returns

Evolution of Corporate Leverage 1938-1948

  • Leverage declined during wartime but increased substantially after 1945
  • Post-war leverage ratios reached over 40%, significantly higher than pre-war levels
  • Pattern suggests firms used more debt financing after tax introduction

Investment Response to Increased Leverage

  • Higher leverage led to increased investment, particularly after 1946
  • Investment effect was strongest in the post-war period (0.412)
  • Demonstrates real economic effects of tax-induced changes in capital structure

Economic Impact: Massive Loss in Dutch Corporate Value

  • Immediate impact of a loss of over 300 million guilders in corporate value
  • Estimated total impact of up to 442 million guilders when including all affected firms
  • Represented over 5% of Dutch GDP

Contribution and Implications

  • First comprehensive analysis of how wartime corporate tax changes affected firm behavior and value
  • Documents significant and lasting effects of wartime policies on corporate financial decisions
  • Shows how firms strategically adjusted capital structure in response to tax policy

Data Sources

  • Value loss chart: Based on Table 1 showing event study results
  • Leverage evolution: Constructed from Table 3 Panel A full sample data
  • Investment response: Derived from Table 6 regression results
  • Economic impact: Calculated from discussion in text regarding GDP impact