BANKS, DEBT AND RISK: ASSESSING THE SPILLOVERS OF CORPORATE TAXES

Serena Fatica,Wouter Heynderickx,Andrea Pagano

doi:10.1111/ecin.12827

Abstract

We find evidence of tax‐driven strategic allocation of debt and asset risk across group entities of European banks. We evaluate the effects that establishing tax neutrality between debt and equity finance has on systemic risk, and show that the degree of coordination in implementing the hypothetical tax reform matters. In particular, a coordinated elimination of the tax advantage of debt would significantly reduce systemic losses in the event of a severe banking crisis. By contrast, uncoordinated tax reforms are not equally beneficial precisely because national tax policies generate spillovers through cross‐border bank activities. (JEL G21, G28, H25)

Highlights

Taxes are a first-order determinant of firms’ capital structure choices (Titman and Wessels, 1988; MacKie-Mason, 1990; Desai et al, 2004)
By granting a rebate to interest payments while taxing the return to equity, corporate income tax systems typically encourage the use of debt rather than equity finance
In this paper we investigate the impact of corporate taxation on capital structure and asset risk choices of banking groups in Europe

Summary

Introduction

Taxes are a first-order determinant of firms’ capital structure choices (Titman and Wessels, 1988; MacKie-Mason, 1990; Desai et al, 2004). The tax benefit of debt encourages excessive corporate indebtedness, and represents an important source of risk, for the highly leveraged financial sector (De Mooij, 2014). In the aftermath of the crisis, amidst the concerted regulatory initiatives to reduce leverage in the financial sector, the perverse incentives of corporate taxes on banks’ debt policies have attracted renewed academic and policy interest. By indirectly penalising equity, standard tax rules undermine the bank solvency and capital adequacy efforts that have been central to the post-crisis reform agenda. By distorting incentives at the microeconomic level, tax policy affects systemic risk (Roe and Tröge, 2017). This is the focus of our analysis

Results

Discussion

Conclusion