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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

Nazi Occupation and Tax Changes

During Nazi occupation (1940-1945), the Dutch economy was overhauled with a profit tax of 55% when corporate profits were previously untaxed in the Netherlands.

Research Approach

The authors studied 280 firms listed on the Amsterdam stock exchange from 1938-1948, tracking how the introduction of corporate taxes affected firm values, leverage decisions, and investments.

Natural Experiment

This historical setting creates a rare research opportunity to study how corporate taxes influence business financing decisions and investment behavior in a dramatic tax regime change.

Rapid Evolution of Dutch Corporate Tax Regime Under Nazi Occupation

Pre-war Nov 1940 May 1942 Post-war 0% Corporate Tax 31.5% Tax Rate 55% Corporate Tax Nazi occupation transformed Dutch taxation
  • Before 1940, Dutch companies paid no corporate profit taxes, unlike most other European countries.
  • The Nazi occupation introduced a profit tax of 11.5% in July 1940, increased to 31.5% by November 1940.
  • In May 1942, the tax rate jumped to 55%, significantly affecting Dutch companies' financial structures.

Major Loss of Firm Value Following Tax Announcements

  • Stock market reactions to tax announcements were strongly negative, indicating investor losses.
  • The November 1940 announcement caused larger value losses (11-13%) than the May 1942 announcement (2-4%).
  • Results were consistent across multiple market indices, confirming the tax change was a significant shock.

Significant Increase in Corporate Debt Levels After Tax Introduction

  • Companies with normal pre-war leverage dramatically increased their debt after 1945, seeking tax advantages.
  • The debt-to-assets ratio increased by 10 percentage points by 1948 compared to pre-tax levels.
  • High-tangibility firms (control group) maintained more stable leverage, confirming the tax-driven motivation.

Corporate Tax Led to Increased Investments by Highly Leveraged Firms

  • Leverage had a stronger positive effect on investment after the war (1946-48) than before.
  • A one-standard-deviation increase in leverage led to 17-20% higher investment post-tax reform.
  • This shows how tax deductibility of interest expenses creates real economic effects through investment incentives.

Contribution and Implications

  • The study documents a significant historical economic expropriation estimated at 5% of Dutch GDP during Nazi occupation.
  • It provides clear evidence that tax policies can significantly alter corporate financing choices toward debt financing.
  • The findings show wartime tax policies had lasting effects, as the corporate tax structure remained after liberation.
  • Companies adapted to the new tax environment by increasing leverage to benefit from interest tax deductions.
  • The increased leverage led to higher investment levels, demonstrating how tax policy affects real economic outcomes.

Data Sources

  • Stock market reaction visualization (Chart 1) uses data from Table 1 showing abnormal returns after tax announcements.
  • Corporate leverage visualization (Chart 2) uses data from Table 3 showing leverage changes over time.
  • Investment effects visualization (Chart 3) uses data from Table 6 showing regression coefficients on investment models.
  • The valuation impact visualization (SVG 2) is based on the authors' estimate of 300 million guilders lost.
  • The tax timeline visualization (SVG 1) is based on the historical tax rate changes described in the article.