Abstract

This paper examines the effects of taxation on the capital structure of banks. We derive testable predictions from a dynamic model of optimal bank liability structure that incorporates bank run, regulatory closure and endogenous default. Using the supervisory data provided by the Bank of Italy, we empirically test these predictions by exploiting exogenous regional variations over time in the Italian tax rates on productive activities (IRAP). Our empirical results show that banks endogenously respond to a reduction in tax rates, by lowering leverage, and by reducing non-deposit liabilities more than deposits. The response on the asset side depends on the financial strength of the banks. Well-capitalized banks respond to a reduction in tax rates by increasing their assets, but poorly-capitalized banks respond by cleaning up their balance sheet.

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Citation

Gambacorta, Leonardo, Giacomo Ricotti, M. Suresh Sundaresan, and Zhenyu Wang. "The Effects of Tax on Bank Liability Structure." Columbia Business School, September 7, 2016.

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