Theft and taxes

This paper analyzes the interaction between corporate taxes and corporate governance. We show that the design of the corporate tax system affects the amount of private benefits extracted by company insiders and that the quality of the corporate governance system affects the sensitivity of tax revenues to tax changes. Analyses of a tax enforcement crackdown in Russia and cross-country data on tax changes support this two-way interaction between corporate governance and corporate taxation.     

Do Federal Home Loan Bank membership and advances increase bank risk-taking?

Since the early 1990s, commercial banks have turned to Federal Home Loan Bank (FHLBank) advances to plug the gap between loan and deposit growth. Is this trend worrisome? On the one hand, advances implicitly encourage risk by insulating borrowers from market discipline. On the other, advances give borrowers greater flexibility to managing interest rate and liquidity risk. And access to FHLBank funding encourages members to reshape their balance sheets in ways that could lower credit risk. Using quarterly financial and supervisory data for banks from 1992 to 2005, we assess the effect of FHLBank membership and advances on risk. The evidence suggests liquidity and leverage risks rose modestly, but interest-rate risk declined somewhat. Credit risk and overall failure risk were largely unaffected. Although the evidence suggest FHLBank membership and advances have had, at best, only a modest impact on bank risk, we caution that our sample period constitutes one observation and that moral hazard could be pronounced if leverage ratios revert to historical norms.     

Corporate tax avoidance and high-powered incentives

This paper analyzes the links between corporate tax avoidance and the growth of high-powered incentives for managers. A simple model demonstrates the role of feedback effects between tax sheltering and managerial diversion in determining how high-powered incentives influence tax sheltering decisions. A novel measure of corporate tax avoidance (the component of the book-tax gap not attributable to accounting accruals) allows for an investigation of the link between tax avoidance and incentive compensation. Increases in incentive compensation tend to reduce the level of tax sheltering, in a manner consistent with a complementary relationship between diversion and sheltering. In addition, this negative effect is driven primarily by firms with relatively weak governance arrangements, confirming a central prediction of the model. These results can help explain the growing cross-sectional variation among firms in their levels of tax avoidance, the undersheltering puzzle, and why large book-tax gaps are associated with subsequent negative abnormal returns.     

Debt,Taxes, and Banks

Understanding the impact on banks’ capital structures of tax biases toward debt finance is critical to assessing policy responses to socially excessive bank leverage—but there is no empirical evidence of its extent. Guided by some simple theory, this paper explores this impact for a large panel of banks in 82 countries. On average, the tax sensitivity of banks’ leverage proves significant and about as large as for nonfinancial firms. Somewhat counterintuitively, but as the theory suggests, taxation has little impact on the use of hybrids. Banks holding smaller equity buffers and larger banks are noticeably less sensitive to tax.     

Corporate tax,capital structure,and the accessibility of bank loans: Evidence from China

In this paper, we investigate whether listed firms in China adjust their capital structure in response to an increase in the corporate tax rate. Although theories of capital structure suggest that corporate tax is an important determinant of capital structure, how exogenous changes of the tax rate affect firms’ leverage decisions has not been fully explored. We examine a unique circumstance in which the Chinese government increased the corporate tax rate of firms that had previously received local government tax rebates. The evidence indicates that these firms increased their leverage when the corporate tax rate increased. Further investigation suggests that the adjustment of leverage was mostly driven by firms with a high level of access to bank loans.     

Taxes and Financial Constraints: Evidence from Linguistic Cues

Using a new measure of financial constraints based on firms’ qualitative disclosures, we find that financially constrained firms—firms that use more negative words in their annual reports—pursue more aggressive tax planning strategies as evidenced by: (1) higher current and future unrecognized tax benefits, (2) lower short‐ and long‐run current and future effective tax rates, (3) increase in tax haven usage for their material operations, and (4) higher proposed audit adjustments from the Internal Revenue Service. We exploit the unexpected closures of local banks as exogenous liquidity shocks to show that firms’ external financial constraints affect their tax avoidance strategies. Overall, the linguistic cues in firms’ qualitative disclosures provide incremental information beyond traditional accounting variables or commonly used effective tax rates to reveal and predict tax aggressiveness, both contemporaneously and in the future.     

Does Germany Collect Revenue from Taxing the Normal Return to Capital?*

A widespread objection to the introduction of consumption tax systems claims that this would lead to high tax revenue losses. This paper investigates the revenue effects of a consumption tax reform in Germany. Our results suggest that the revenue losses would be surprisingly low. We find a maximum revenue loss of 1.6 per cent of annual GDP. In some years, we even find tax revenue gains. This implies that the current tax system collects little revenue from taxing the normal return to capital. Based on these results, we calculate a macroeconomic measure of the effective tax rate on capital income.     

Bank consolidation and new business formation

As the trend of bank consolidation activities continues to grow in the US and globally, the debate on the impact of such consolidation on small business credits and activities are still inconclusive. Building on the existing research [Berger, A.N., Saunders, A., Scalise, J.M., Udell, G.F., 1998. The effects of bank mergers and acquisitions on small business lending. Journal of Financial Economics 50, 187–229]; [Black, S.E., Strahan, P.E., 2002. Entrepreneurship and bank credit availability. Journal of Finance LVII (6), 2807–2833], this paper investigates the effects of the actual intensity of bank consolidation on the formation of new businesses in the US local markets. Evidence portrays that in the short-run, the overall intensity of bank consolidation is negatively related to the rate of new business formation, and this negative relationship is primarily driven by consolidations initiated by large acquirers. On the contrary, consolidations between small-to-medium sized banks show a positive impact on new business development and these results are consistent even when the M&As are distinguished with respect to in-market or out-of-market acquirers initiating the deals. However, two years after the consolidations, the evidence reveals a positive and significant impact on the rate of new business formation in the local markets for consolidations initiated by large in-market acquirers.     

Destination taxation and evasion: Evidence from U.S. inter-state commodity flows

Tax evasion has been an important issue in the accounting literature for several decades, but the focus has been on corporate income taxes. We develop a new way to examine tax evasion that focuses on corporate transactions, rather than corporate profits. Specifically, we examine how commodity flows respond to destination sales taxes, allowing for tax evasion as a function of distance between trade partners. After accounting for transportation costs, we find that the effect of taxes decreases as distance increases. This is consistent with the notion that longer distances between trade partners hinder government oversight and increase the likelihood of successful tax evasion. Our results are robust with respect to outliers, strategic neighbor effects, information sharing agreements and other re-specifications. These results are important to policymakers because they evidence the difficulty of enforcing destination taxation in open economies such as U.S. states and the European Union.     

Financial Statements as Monitoring Mechanisms: Evidence from Small Commercial Loans

Using a data set that records banks’ ongoing requests of information from small commercial borrowers, we examine when banks use financial statements to monitor borrowers after loan origination. We find that banks request financial statements for half the loans and this variation is related to borrower credit risk, relationship length, collateral, and the provision of business tax returns, but in complex ways. The relation between borrower risk and financial statement requests has an inverted U‐shape; and tax returns can be both substitutes and complements to financial statements, conditional on borrower characteristics and the degree of bank–borrower information asymmetry. Frequent financial reporting is used to monitor collateral, but only for non–real estate loans and only when the collateral is easily accessible to lenders. Collectively, our results provide novel evidence of a fundamental information demand for financial reporting in monitoring small commercial borrowers and a specific channel through which banks fulfill their role as delegated monitors.     

How Should Business Profit Be Taxed? Some Thoughts on Conceptual Developments During the Lifetime of the IFS*

This paper reviews developments since the 1970s in economic thinking about the design of taxes on business profit. It charts developments from proposals for a cash flow tax from the Meade Committee, to refinements of this in the form of an ‘Allowance for Corporate Equity’ and the levying of the cash flow tax in the country of destination. It describes how the development of international trade and investment has led to ever‐increasing problems in the international tax system with respect to economic efficiency, profit shifting, complexity and tax competition. It also identifies why a response to these problems requires a major reform in the location of taxation.     

The effectiveness and valuation of political tax minimization

We find evidence suggesting that corporate lobbying for tax purposes over the period 1999–2009 is one method by which firms managed corporate taxes. Furthermore, tax management strategies employed by these politically active firms were valued by shareholders. Firms lobbying on tax issues have lower book effective taxes and greater discretionary permanent differences in GAAP and IRS taxable income. Investors place a premium on lobbying activities for tax purposes unless the firm already has a low effective tax rate or very high book-tax differences. We conclude that lobbying political officials is one method by which firms manage risks attendant an aggressive tax strategy.     

Does the stock market value bank diversification?

This paper investigates whether or not functionally diversified banks have a comparative advantage in terms of long-term performance/risk profile compared to their specialized competitors. To that end, this study uses market-based measures of return potential and bank risk. We calculate the franchise value over time of European banks as a measure of their long-run performance potential. In addition, we measure risk as both the systematic and the idiosyncratic risk components derived from a bank stock return model. Finally, we analyze the return/risk trade-off implied in different functional diversification strategies using a panel data analysis over the period 1989–2004. A higher share of non-interest income in total income affects banks’ franchise values positively. Diversification of revenue streams from distinct financial activities increases the systematic risk of banks while the effect on the idiosyncratic risk component is non-linear and predominantly downward-sloping. These findings have conflicting implications for different stakeholders, such as investors, bank shareholders, bank managers and bank supervisors.     

Size and earnings volatility of US bank holding companies

We examine whether bank earnings volatility depends on bank size. Using quarterly data for bank holding companies in the United States for the period 1995Q1–2010Q3 and controlling for the quality of management, leverage, and diversification, we find that bank size reduces return volatility. However, the effect is non-linear: when bank size exceeds a certain threshold (about US$5 billion) size is positively related to earnings volatility. The recent financial crisis decreased the threshold beyond which the impact of size on volatility turns positive.     

Real estate prices and bank stability

Real estate prices can deviate from their fundamental value due to rigid supply, heterogeneity in quality, and various market imperfections, which have two contrasting effects on bank stability. Higher prices increase the value of collateral and net wealth of borrowers and thus reduce the likelihood of credit defaults. In contrast, persistent deviations from fundamentals may foster the adverse selection of increasingly risky creditors by banks seeking to expand their loan portfolios, which increases bank distress probabilities. We test these hypotheses using unique data on real estate markets and banks in Germany. House price deviations contribute to bank instability, but nominal house price developments do not. This finding corroborates the importance of deviations from the fundamental value of real estate, rather than just price levels or changes alone, when assessing bank stability.     

Households’ foreign currency borrowing in Central and Eastern Europe

Foreign currency loans represent an important feature of recent financial developments in CEECs. This might pose a serious challenge for macroeconomic stability. Against this background, we study the determinants of foreign currency loans of households, using data on the behavior of households in nine CEECs. Our results reveal that foreign currency loans are driven by households’ lack of trust in the stability of the local currency and in domestic financial institutions. Moreover, special factors including remittances and expectations of euro adoption play an important role in selected regions. The financial crisis reduced foreign currency borrowing, but there is some indication this effect might be only temporary.