Taxing (Shadow) Banks: A Pigovian Model

Abstract

This lengthy chapter brings home a critical question regarding an adequate tax model for financial institutions (FIs) and shadow banking entities. Given that leverage is a constitutive factor of the shadow banking business model, corporate tax systems have an embedded debt bias and credit-, maturity- and liquidity transformation occur outside the regulated banking sphere in the shadow banking segments, the author wonders if a Pigovian tax model, whereby the negative externalities caused would trigger tax liabilities, would be more appropriate to neutralize possible shadow banking exposures. Starting from the contemporary tax system, the older and more recent literature on Pigovian taxes, he expands his Pigovian tax model designed initially in 2015 for the financial sector and shadow banking entities, in particular using the aforementioned constitutive elements as drivers for the design of the model. But Pigovian taxes are politically a difficult topic whether it is for environmental purposes, reducing obesity (sugar tax) or reducing systemic risk in the financial markets.