Regulation, Tax and Capital Structure: Evidence from Administrative Data on Italian Banks

Abstract

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.

Changes in the Cost of Bank Equity and the Supply of Bank Credit

“…We find that the end of an ACE has the opposite effect to its implementation: Italian banks have decreased equity ratios and total equity more rapidly than other European banks. Our results are consistent with Bond et al (2016) who show that while the leverage of Italian banks leverage has been sensitive to changes in regional tax rates over the 1998-2011 period, the effect was lower during the period of the ACE in Italy. At the same time, banks have been holding more securities, while decreasing the share of loans to total assets.…”

“…The IRAP decreased significantly starting from 2000, hence decreasing the cost of capital for banks (Bond et al, 2016;Gambacorta et al, 2016). 8…”

The Effects of Tax on Bank Liability Structure

“…This result is in line with Célérier et al (2016) on the effects of tax reforms in Europe. Along similar lines, Bond et al (2016) investigate the effects of tax on the capital structure of banks by employing exogenous regional and time variation in the rate of IRAP (Imposta regionale sulle attività produttive) and data on Italian mutual banks (credit cooperative banks, or CCBs). They show that changes in the IRAP rate affect leverage and the effect is larger for smaller or slow-growing banks.…”

“…We follow Bond et al (2016) and use the Italian CCBs and IRAP as a laboratory. The exogenous variation in the tax treatment of CCBs allows us to exploit the variations in the tax exposure of such banks across regions and over time.…”

Is bank capital sensitive to a tax allowance on marginal equity?

“…Thirdly, we add the statutory corporate income tax rate to control for changes in the tax rate affecting either the control or treatment group. The banking literature has documented that bank capital has a lagged response to tax rate changes (e.g., Bond et al, 2016;De Mooij and Keen, 2016;Hemmelgarn and Teichmann, 2014). During the period of analysis some corporate income tax changes took place 19 We also tackle this aspect running a placebo test that we show in Table 7, column (6).…”