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Do Tax Changes Affect Credit Markets and Financial Frictions? Evidence from Credit Spreads

Listed author(s):
  • Winter, Christoph
  • Kraus, Beatrice

In this paper, we empirically document a link between tax changes and financial market conditions. Using the Romer and Romer (2010) narrative record of exogenous federal tax liability changes for the US, we show that an increase in taxes leads to higher risk premia for corporate bonds issued by financial and non-financial firms. Consistent with recent theories of intermediary asset pricing, we demonstrate that risk premia are driven by intermediaries' balance sheet conditions, which -- according to our results -- are in turn affected by tax changes. Two tax acts are particularly relevant for the transmission of taxes to financial market conditions, namely the Tax Reform Act of 1986 and the Jobs and Growth Tax Relief Reconciliation Act of 2003. Interestingly, none of these two tax acts specifically targeted the financial sector. Therefore, an important implication of our results is that any tax change can potentially spill over to financial market conditions, with the associated consequences for real economic activity.

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File URL: https://www.econstor.eu/bitstream/10419/145636/1/VfS_2016_pid_6552.pdf
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Paper provided by Verein für Socialpolitik / German Economic Association in its series Annual Conference 2016 (Augsburg): Demographic Change with number 145636.

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Date of creation: 2016
Handle: RePEc:zbw:vfsc16:145636
Contact details of provider: Web page: http://www.socialpolitik.org/
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