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 (1998-2011).
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.
