Edited by Sajid Chaudhry and Andrew W Mullineux
The global financial crisis of 2007–09 severely shocked the world economy, and there has been growing concern about whether corporate income tax systems which favour the use of debt over equity finance have potentially amplified the risks to financial stability. In particular, corporate income taxation is identified as one of the possible sources which might have indirectly contributed to the financial crisis of 2007–09 owing to the asymmetric tax treatment of debt and equity on the capital structures of financial institutions. The consensus view is that while tax distortions to financial institutions’ capital structure have not directly influenced the financial crisis they have nevertheless increased the vulnerability of the financial system to shocks due to socially excessive levels of leverage incurred by banks, which has threatened the stability of the financial system and put the solvency of banks at risk (de Mooij et al., 2013). As Keen and de Mooij (2012) show, the ‘debt bias’ caused by the deductibility against corporate taxation of interest payments but not of the returns to equity encourages firms to finance their projects by debt rather than equity, which in the case of banks induces them to leverage excessively and potentially increase their risk of default. The subsequent empirical work of de Mooij et al. (2013) confirms that greater tax bias is associated with significantly higher levels of bank leverage, and this in turn is associated with a significantly greater chance of banking crises.
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