Bank Profitability and Taxation

Abstract

This paper investigates how bank profitability is affected by corporate income tax (CIT) using aggregate data on the banking sector of the main industrialized countries for the period 1981-2003. Two main novelties emerge with respect to the existing literature. First, the paper explicitly considers that CIT is not specific to the banking sector, so that changes in the CIT rate can affect both banks and borrowing firms' behavior. Thus, with the help of a simple theoretical model we derive a set of predictions about the impact of CIT on banks' income statement. Second, by considering all the main components of banks' profit and loss accounts, we are able to test such predictions and to disentangle the extent to which a bank is able to shift its tax-burden onto its borrowers, depositors, and purchasers of fee-generating services. It turns out that CIT has a substantial impact on the composition of banking sector revenues but cannot explain large differences in the level of profitability across countries.

Keywords: tax-shifting, corporate income tax, bank profitability

JEL Classification: C53, G20, G21