The Impact of Explicit and Implicit State Taxation of U.S. Government Obligations on the Structure of Banks' Investment and Financing Portfolios

Posted: 12 Oct 2001

See all articles by Anne Beatty

Anne Beatty

Ohio State University (OSU) - Department of Accounting & Management Information Systems

David G. Harris

Syracuse University - Joseph I. Lubin School of Accounting

Abstract

In this paper we examine the effects of differential state taxation of U.S. Government obligations (USOs) on how banks structure their investment and financing portfolios, the riskiness of banks' assets, and how implicit tax effects are impounded in investments' returns. Twenty-seven states tax USOs (taxing states) and twenty-three states and the District of Columbia do not (non-taxing states). We find that banks in taxing states hold significantly greater amounts of USOs, which are among the least risky assets banks can hold, and we find that these banks hold a less risky mix of assets. Consistent with compensating for the lower risk of their asset mix, we also find that these banks hold less capital. Taken together, these results are consistent with effective bank regulation enforcement, since banks have similar capital to risk weighted asset ratios in spite of differing tax-based incentives to hold riskless assets. We also examine the impact of implicit taxes on banks' USO holdings and related accounts and find that in taxing states banks' USO investments are decreasing in their state tax rate. We also find corresponding increases in asset riskiness which banks do not appear to fully compensate for in the highest state-tax-rate states. Finally, the effects shown in this paper are economically significant. For example, we find that banks operating in taxing states hold, on average, 40 percent less USOs than banks in non-taxing states.

Suggested Citation

Beatty, Anne L. and Harris, David G., The Impact of Explicit and Implicit State Taxation of U.S. Government Obligations on the Structure of Banks' Investment and Financing Portfolios. Journal of American Taxation Assoc. (JATA), Vol. 23, No. 2, Fall 2001. Available at SSRN: https://ssrn.com/abstract=285806

Anne L. Beatty (Contact Author)

Ohio State University (OSU) - Department of Accounting & Management Information Systems ( email )

2100 Neil Avenue
Columbus, OH 43210
United States

David G. Harris

Syracuse University - Joseph I. Lubin School of Accounting ( email )

Whitman School of Management
721 University Ave
Syracuse, NY 13244-2130
United States
315-443-3362 (Phone)
315-443-5457 (Fax)

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