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

Sven Langedijk, Gaëtan Nicodème, Andrea Pagano and Alessandro Rossi
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Andrea Pagano: European Commission – Joint Research Center

No 50, Taxation Papers from Directorate General Taxation and Customs Union, European Commission

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.

Keywords: Debt bias; Systemic crisis; Capital structure; Taxation; Allowance for Corporate Equity; Public finance; Bail out (search for similar items in EconPapers)
JEL-codes: G01 G28 G32 H25 (search for similar items in EconPapers)
Pages: 48 pages
Date: 2014-10
New Economics Papers: this item is included in nep-ban, nep-cfn, nep-eec, nep-pbe and nep-pub
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Citations: View citations in EconPapers (10)

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