Abstract
I use staggered changes in the taxation of banks by U.S. states to show how banks adjust their capital structure in response to taxes. A one percentage point increase in the income tax rate leads to a decrease in the ratio of equity to total assets of 15 basis points. The effect is symmetric fortax increases and decreases, but heterogeneous in that small and strongly capitalized banks react more. Banks appear to engage in regulatory arbitrage activities for keeping down their regulatory risk measures in response totaxes, consistent with a motive of keeping regulatory ratios at acceptable levels despite increasing their leverage. Finally, higher taxes may decrease banks’ ability to survive crises.