The tax burden is a relevant component of the cost of credit. The paper analyses the effects of the Italian tax system on the cost of credit, disentangling the contributions of tax rates and the provisions on interest costs, loan loss provisions and the cost of equity (ACE). The analysis extends to the banking sector a model used to compute tax burden indicators for non-financial firms, allowing for consideration of the complex interactions between taxation, accounting rules, company law and regulation.
The results show that ACE, introduced in 2011, has been effective in reducing the tax incentive to debt, and that until 2015 the deductibility limits on loan loss provisions could have generated a number of distortions, by discriminating between borrowers, economic sectors and geographical areas, inducing a pro-cyclical increase in the cost of credit during downturns, and providing disincentives to the timely setting aside of sufficient provisions for non-performing loans.
