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How Should Financial Intermediation Services be Taxed?

  • Ben Lockwood

    ()

    (Oxford University Centre for Business Taxation, CEPR and Department of Economics, University of Warwick)

This paper considers the optimal taxation of savings intermediation and payment services in a dynamic general equilibrium setting, when the government can also use consumption and income taxes. When payment services are used in strict proportion to final consumption, and the cost of intermediation services is fixed and the same across firms, the optimal taxes are generally indeterminate. But, when firms differ exogenously in the cost of intermediation services, the tax on savings intermediation should be zero. Also, when household time and payment services are substitutes in transactions, the optimal tax rate on payment services is determined by the returns to scale in the conditional demand for payment services, and is generally different to the optimal rate on consumption goods. In particular, with constant returns to scale, payment services should be untaxed. These results can be understood as applications of the Diamond-Mirrlees production efficiency theorem. Finally, as an extension, we endogenize intermediation, in the form of monitoring, and show that it may be oversupplied in equilibrium when banks have monopoly power, justifying a Pigouvian tax in this case.

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Paper provided by Oxford University Centre for Business Taxation in its series Working Papers with number 1014.

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Date of creation: 2010
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Handle: RePEc:btx:wpaper:1014
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  1. Brown, Martin & Jappelli, Tullio & Pagano, Marco, 2008. "Information Sharing and Credit: Firm-Level Evidence from Transition Countries," Proceedings of the German Development Economics Conference, Zurich 2008 3, Verein für Socialpolitik, Research Committee Development Economics.
  2. Holmstrom, Bengt & Tirole, Jean, 1997. "Financial Intermediation, Loanable Funds, and the Real Sector," The Quarterly Journal of Economics, MIT Press, vol. 112(3), pages 663-91, August.
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  4. Mikhail Golosov & Narayana R. Kocherlakota & Aleh Tsyvinski, 2001. "Optimal indirect and capital taxation," Working Papers 615, Federal Reserve Bank of Minneapolis.
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  6. Faig, Miquel, 1988. "Characterization of the optimal tax on money when it functions as a medium of exchange," Journal of Monetary Economics, Elsevier, vol. 22(1), pages 137-148, July.
  7. Christopher Phelan & Ennio Stacchetti, 2001. "Sequential Equilibria in a Ramsey Tax Model," Econometrica, Econometric Society, vol. 69(6), pages 1491-1518, November.
  8. Javier Bianchi & Enrique G. Mendoza, 2010. "Overborrowing, Financial Crises and 'Macro-prudential' Taxes," NBER Working Papers 16091, National Bureau of Economic Research, Inc.
  9. Correia, Isabel H., 1996. "Should capital income be taxed in the steady state?," Journal of Public Economics, Elsevier, vol. 60(1), pages 147-151, April.
  10. Diamond, Douglas W, 1991. "Monitoring and Reputation: The Choice between Bank Loans and Directly Placed Debt," Journal of Political Economy, University of Chicago Press, vol. 99(4), pages 689-721, August.
  11. Jack, W., 1998. "The Treatment of Financial Services Under a Broad-Based Consumption Tax," CEPR Discussion Papers 394, Centre for Economic Policy Research, Research School of Economics, Australian National University.
  12. Andrew Atkeson & V.V. Chari & Patrick J. Kehoe, 1999. "Taxing capital income: a bad idea," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Sum, pages 3-17.
  13. Besanko, David & Kanatas, George, 1993. "Credit Market Equilibrium with Bank Monitoring and Moral Hazard," Review of Financial Studies, Society for Financial Studies, vol. 6(1), pages 213-32.
  14. Chamley, Christophe, 1986. "Optimal Taxation of Capital Income in General Equilibrium with Infinite Lives," Econometrica, Econometric Society, vol. 54(3), pages 607-22, May.
  15. Kevin C. Murdock & Thomas F. Hellmann & Joseph E. Stiglitz, 2000. "Liberalization, Moral Hazard in Banking, and Prudential Regulation: Are Capital Requirements Enough?," American Economic Review, American Economic Association, vol. 90(1), pages 147-165, March.
  16. Poddar, Satya & English, Morley, 1997. "Taxation of Financial Services Under a Value-Added Tax: Applying the Cash-Flow Approach," National Tax Journal, National Tax Association, vol. 50(1), pages 89-111, March.
  17. Berger, Allen N & Udell, Gregory F, 1995. "Relationship Lending and Lines of Credit in Small Firm Finance," The Journal of Business, University of Chicago Press, vol. 68(3), pages 351-81, July.
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