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Debt Bias in Corporate Taxation and the Costs of Banking Crises in the EU

Author

Listed:
  • Sven Langedijk

    (European Commission – Joint Research Center)

  • Gaëtan Nicodème

    (European Commission)

  • Andrea Pagano

    (European Commission – Joint Research Center)

  • Alessandro Rossi

    (European Commission – Joint Research Center)

Abstract

During the period 2008-2012, EU governments incurred substantial costs bailing out banks. As corporate income taxation (CIT) in most countries still favors debt- over equityfinancing, reducing or eliminating this debt bias would complement regulatory reforms reducing costs of financial crises. To estimate this effect, we use a two-step approach. First, using panel regressions on a dataset of 32,833 bank-year observations we find sizable long-run effects of CIT on leverage in the EU. Second, we simulate the effect of tax reforms on bank losses using a Vasicek-based model with actual banks’ balance sheets to estimate costs of systemic crises for six large EU member states. Even if the tax elasticity of bank leverage is taken at the lower end of the ranges found in recent literature, eliminating the debt bias could lead to reductions of public finance losses in the range of 60 to 90%. The results hold even when considering much smaller effects for banks that are close to the regulatory minimum capital requirement of the Basel III framework. Even when asset portfolio risk is allowed to increase endogenously and considering conservative ranges of the parameter space, we conclude that tax reforms to remove the debt bias can result in very sizable reductions in risks and costs of financial crises.

Suggested Citation

  • Sven Langedijk & Gaëtan Nicodème & Andrea Pagano & Alessandro Rossi, 2014. "Debt Bias in Corporate Taxation and the Costs of Banking Crises in the EU," Taxation Papers 50, Directorate General Taxation and Customs Union, European Commission.
  • Handle: RePEc:tax:taxpap:0050
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    File URL: https://ec.europa.eu/taxation_customs/sites/taxation/files/resources/documents/taxation/gen_info/economic_analysis/tax_papers/taxation_paper_50.pdf
    File Function: final version, 2014
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    1. repec:eee:jfinec:v:125:y:2017:i:2:p:266-285 is not listed on IDEAS
    2. repec:eee:jfinin:v:30:y:2017:i:c:p:86-106 is not listed on IDEAS
    3. Sachverständigenrat zur Begutachtung der Gesamtwirtschaftlichen Entwicklung (ed.), 2015. "Zukunftsfähigkeit in den Mittelpunkt. Jahresgutachten 2015/16," Annual Economic Reports / Jahresgutachten, German Council of Economic Experts / Sachverständigenrat zur Begutachtung der gesamtwirtschaftlichen Entwicklung, volume 127, number 201516.
    4. Pieter Van der Zwan & Danie Schutte & Waldo Kruggel & Joel Seshabela & Hayley Reynolds & Londiwe Khoza, 2017. "An evaluation of interest deduction limitations to counter base erosion in South Africa," WIDER Working Paper Series 035, World Institute for Development Economic Research (UNU-WIDER).

    More about this item

    Keywords

    Debt bias; Systemic crisis; Capital structure; Taxation; Allowance for Corporate Equity; Public finance; Bail out;

    JEL classification:

    • G01 - Financial Economics - - General - - - Financial Crises
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
    • H25 - Public Economics - - Taxation, Subsidies, and Revenue - - - Business Taxes and Subsidies

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