Business Taxation and Its Impact on Capital Structure : Evidence from Italian Banks

This paper explores the effect of taxation on the capital structure of banks. To identify the effect of taxes, we exploit exogenous regional variations in the rate of the Italian tax on productive activities (IRAP) using administrative, confidential data provided by the Bank of Italy. We find that taxation affects leverage of smaller banks (that is, banks in the lowest three quartiles of total assets) but does not affect leverage of banks in the top quartile of total assets. Taxation also affects leverage of slow growing banks but it does not affect leverage of fast growing banks. Larger and faster growing banks also display higher leverage. Overall, banks with higher leverage do not respond to tax. We control for regulatory capital requirements using a new measure of leverage called maximum leverage ratio for each bank-year observation and the results do not change qualitatively. Maximum leverage only affects leverage of larger and faster growing banks, those for which there is no tax effect. Additionally, the heterogeneity in leverage levels across banks of different sizes and growth groups disappears when controlling for maximum leverage. These results suggest that for banks with higher leverage, the regulatory requirements are binding and therefore, they are less sensitive to tax. JEL Classification: G21; G32; G38; H25; H32.