The European Central Bank (ECB) has published a working paper finding that municipal corporate tax increases in Portugal weaken firms’ liquidity and credit quality, followed by declines in employment and productivity. Small firms are most affected, with increased borrowing appearing to cover cash shortfalls rather than exploit the tax deductibility of interest. The analysis links corporate accounts to the Bank of Portugal’s credit registry over 2009-2021 and compares firms exposed to municipal surtax increases with firms in municipalities without tax changes during the relevant comparison period.
The average surtax increase studied is 0.88 percentage points, raising firms’ effective tax rate by approximately 0.76 percentage points immediately. Net financial debt rises about 7% on impact as liquidity falls. Firms delay payments to suppliers and increase borrowing primarily at shorter maturities. Implicit interest rates rise by 0.47 percentage points after one year, while the share of firms with nonperforming loans increases by about 1.4 percentage points after four years. Larger firms show no statistically significant financial response.
Employment declines about 2%, while total factor productivity falls around 2.5% after three years. Labor costs fall more than employment, suggesting workers bear part of the tax burden through lower compensation as well as job losses. The probability of firm exit rises by 2.2 percentage points and relocation by 7.7 percentage points. Neighboring municipalities gain some firms but record no detectable output gains. The sequence of financial deterioration and weaker activity is consistent with financing pressures amplifying the tax shock, although the study does not separately establish that causal channel.