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Tax Reforms and the Capital Structure of Banks

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  • Thomas Hemmelgarn

    () (European Commission)

  • Daniel Teichmann

    () (University of Frankfurt)

Abstract

The paper studies the link between corporate income tax reforms and domestic bank entities' financing decisions. We use a dataset of corporate income tax (CIT) reforms and estimate the effect of tax rate changes on leverage, dividend policies and earnings management of banks. The results suggest that taxation influences all three variables in the first three years after the reform. Leverage increases with the CIT rate. The reason is that the statutory CIT rate determines the value of the debt tax shield. A higher tax rate increases incentives to use debt finance when interest payments are deductible from the CIT base. The tax effects we find are statistically and economically significant but considerably lower than those found in previous research. Also, dividend pay-outs increase after an increase of CIT rates. This could indicate that banks actively manage their pay-out policies around tax reforms and adjust their capital structure with changes in dividends. Furthermore, banks increase loss loan reserves in anticipation of tax rate cuts since losses become less valuable with lower CIT rates. In the context of the current regulatory reform in the financial sector, which focuses strongly on improving equity ratios of banks, our results suggest that future tax policies should focus on eliminating the favourable treatment of debt for banks. The reason is that this distortion at least partly undermines the regulatory objectives of increasing (regulatory) capital.

Suggested Citation

  • Thomas Hemmelgarn & Daniel Teichmann, 2013. "Tax Reforms and the Capital Structure of Banks," Taxation Papers 37, Directorate General Taxation and Customs Union, European Commission.
  • Handle: RePEc:tax:taxpap:0037
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    References listed on IDEAS

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    Citations

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    Cited by:

    1. Franziska Bremus & Jeremias Huber, 2016. "Corporate Taxation, Leverage, and Macroeconomic Stability," DIW Roundup: Politik im Fokus 93, DIW Berlin, German Institute for Economic Research.
    2. European Commission, 2013. "Tax reforms in EU Member States - Tax policy challenges for economic growth and fiscal sustainability – 2013 Report," Taxation Papers 38, Directorate General Taxation and Customs Union, European Commission.
    3. Horvath, B.L., 2013. "The impact of Taxation on Bank Leverage and Asset Risk," Discussion Paper 2013-076, Tilburg University, Center for Economic Research.
    4. Langedijk, Sven & Nicodème, Gaëtan & Pagano, Andrea & Rossi, Alessandro, 2015. "Debt Bias in Corporate Income Taxation and the Costs of Banking Crises," CEPR Discussion Papers 10616, C.E.P.R. Discussion Papers.
    5. repec:eee:jiaata:v:28:y:2017:i:c:p:31-42 is not listed on IDEAS
    6. Gambacorta, Leonardo & Ricotti, Giacomo & Sundaresan, Suresh M & Wang, Zhenyu, 2017. "The effects of tax on bank liability structure," CEPR Discussion Papers 11893, C.E.P.R. Discussion Papers.
    7. Steve Bond & Kyung Yeon Ham & Giorgia Maffini & Andrea Nobili & Giacomo Ricotti, 2016. "Regulation, tax and capital structure: evidence from administrative data on Italian banks," Questioni di Economia e Finanza (Occasional Papers) 361, Bank of Italy, Economic Research and International Relations Area.
    8. repec:eee:jfinin:v:30:y:2017:i:c:p:86-106 is not listed on IDEAS
    9. Jost H. Heckemeyer & Ruud A. de Mooij, 2017. "Taxation and Corporate Debt: Are Banks Any Different?," National Tax Journal, National Tax Association;National Tax Journal, vol. 70(1), pages 53-76, March.

    More about this item

    Keywords

    Corporate income tax; tax reform; debt-equity bias; leverage; banks.;

    JEL classification:

    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • H25 - Public Economics - - Taxation, Subsidies, and Revenue - - - Business Taxes and Subsidies
    • H32 - Public Economics - - Fiscal Policies and Behavior of Economic Agents - - - Firm

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