Title: Debt Bias in Corporate Taxation and the Costs of Banking Crises in the EU
Authors: LANGEDIJK SvenNICODEME GaetanPAGANO AndreaROSSI Alessandro
Citation: Taxation Papers no. 50 p. 1-37
Publisher: European Commission
Publication Year: 2014
JRC N°: JRC94081
ISSN: 1725-7565 (pdf)
ISSN 1725-7557 (print)
URI: http://ec.europa.eu/taxation_customs/resources/documents/taxation/gen_info/economic_analysis/tax_papers/taxation_paper_50.pdf
http://publications.jrc.ec.europa.eu/repository/handle/JRC94081
DOI: 10.2778/70489
10.2778/70485
Type: Articles in periodicals and books
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 equity financing, 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.
JRC Directorate:Space, Security and Migration

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