The bank leverage response to tax shield changes

Felix Ward and Casper de Vries
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Felix Ward: Erasmus University Rotterdam
Casper de Vries: Erasmus University Rotterdam

No 26-016/VI, Tinbergen Institute Discussion Papers from Tinbergen Institute

Abstract: Does the preferential tax treatment of debt over equity cause banks to increase their leverage? We construct a novel dataset tracing the evolution of the debt tax shield for banks in advanced economies from 1870 to 2020. Exploiting variation from nearly all changes in banking-sector tax shields since the nineteenth century, we show that a 1 percentage point increase in the tax shield reduces bank capital ratios by 0.25-0.8 percentage points. Our estimates suggest that the tax advantage of debt was an important driver of the rise in bank leverage during the twentieth century.

Keywords: corporate income taxation; debt bias; interest deductibility; financial stability (search for similar items in EconPapers)
JEL-codes: E44 G21 G32 (search for similar items in EconPapers)
Date: 2026-04-02
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