Discussion paper

DP10616 Debt Bias in Corporate Income Taxation and the Costs of Banking Crises

Corporate income taxation (CIT) in most countries favors debt over equity financing, leading to over-indebtedness. This problem is particularly acute for the financial sector. We estimate financial-stability benefits of eliminating this debt bias. We estimate the long-run effects of CIT on bank leverage and, using a Vasicek-based model of banking crisis losses, we find that eliminating this debt bias could reduce public finance losses in the range of 30 to 70%. These results hold even for conservative estimates of bank-leverage and portfolio-risk effects of CIT changes.

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Citation

Nicodème, G, S Langedijk, A Rossi and A Pagano (2015), ‘DP10616 Debt Bias in Corporate Income Taxation and the Costs of Banking Crises‘, CEPR Discussion Paper No. 10616. CEPR Press, Paris & London. https://cepr.org/publications/dp10616