Tax Reforms and the Capital Structure of Banks

Thomas Hemmelgarn () and Daniel Teichmann ()
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Daniel Teichmann: University of Frankfurt

No 37, Taxation Papers from Directorate General Taxation and Customs Union, European Commission

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.

Keywords: Corporate income tax; tax reform; debt-equity bias; leverage; banks. (search for similar items in EconPapers)
JEL-codes: G21 H25 H32 (search for similar items in EconPapers)
Pages: 35 pages
Date: 2013-10
New Economics Papers: this item is included in nep-acc, nep-pbe and nep-pub
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (10)

Published in International Tax and Public Finance: Volume 21, Issue 4 (2014), Page 645-693

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Journal Article: Tax reforms and the capital structure of banks (2014)
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