This paper explores the effect of taxation on the capital structure of banks. For identification, we exploit exogenous regional variations in the rate of the Italian tax on productive activities (IRAP) using administrative, confidential data on regional banks provided by the Bank of Italy (1998)(1999)(2000)(2001)(2002)(2003)(2004)(2005)(2006)(2007)(2008)(2009)(2010)(2011). We find that IRAP rate changes do not always lead to a change in banks' leverage: banks close to the regulatory constraints do not change their leverage when tax rates change. This holds true for both tax cuts and tax hikes. Among less constrained entities, the leverage of smaller banks is more responsive to changes in tax rates than that of larger banks. Overall, the tax system has little effect on the capital structure of banks, especially for larger and possibly more systemically important institutions; regulatory constraints instead seem to be a first-order determinant. Our findings cast doubt on the role of the tax system as a cause or tool for addressing the negative externalities of excessive leverage in the banking system.

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Following the establishment of the Single Supervisory Mechanism (SSM), concerns about having a level playing field become more important due to the heterogeneity in bank taxation rules across Europe: measuring the tax burden can provide a first rough measure of the extent of heterogeneity across countries. After a review of the main differences in banks taxation between Italy, France, Germany, Spain and the UK, the paper provides estimates for the tax burden and deferred tax assets in these countries over the years 2006-2014; the impact of differences in taxation on bank profitability is also examined. Moreover, the paper carries out a more in-depth analysis of Italian banks by considering both individual balance sheet data and aggregate tax return data. The impact of tax measures on financial stability and on profitability is further analysed. The comparative analysis points to a wide heterogeneity across countries in the tax treatment of the banking sector. This suggests that it would be advantageous to explore possible ways to make the tax systems of the countries participating in the SSM more homogeneous; a first step could be to harmonize tax bases.JEL Classification: G21, H25, H87, K34.