Working Paper: CEPR ID: DP10616
Authors: Sven Langedijk; Gaetan Nicodeme; Andrea Pagano; Alessandro Rossi
Abstract: Corporate income taxation (CIT) in most countries favors debt over equity financing, leading to over-indebtedness. This problem is particularly acute for the financial sector. We estimate financial-stability benefits of eliminating this debt bias. We estimate the long-run effects of CIT on bank leverage and, using a Vasicek-based model of banking crisis losses, we find that eliminating this debt bias could reduce public finance losses in the range of 30 to 70%. These results hold even for conservative estimates of bank-leverage and portfolio-risk effects of CIT changes.
Keywords: Capital Structure; Debt Bias; Public Finance; Systemic Risk; Taxation
JEL Codes: G01; G28; G32; H25
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Elimination of Debt Bias (H69) | Reduction in Public Finance Losses during Banking Crises (F65) |
| Regulatory Requirements and Market Conditions (G18) | Bank Leverage (G21) |
| Corporate Income Tax (CIT) (H25) | Bank Leverage (G21) |
| Higher Corporate Income Tax (CIT) (H29) | Increased Bank Leverage (F65) |
| Tax Incentives Favoring Debt Financing (H20) | Increased Bank Leverage (F65) |
| Corporate Income Tax (CIT) (H25) | Over-Indebtedness in the Banking Sector (F65) |