Scandinavian Working Papers in Economics

SSE/EFI Working Paper Series in Economics and Finance,
Stockholm School of Economics

No 612: Do Inflation and High Taxes Increase Bank Leverage?

Per Hortlund ()
Additional contact information
Per Hortlund: Dept. of Economics, Stockholm School of Economics, Postal: The Ratio Institute, P.O. Box 5095, SE-102 42 Stockholm, Sweden

Abstract: Does the combination of inflation and high corporate taxes explain the increase in bank leverage in the 20th century? Inflation automatically increases bank debt, while high corporate taxes hinder capital accumulation. Capital ratios therefore drop, until leverage-induced returns are sufficient to uphold them at constant levels. This theory was confronted with Swedish bank data 1870–2001. Bank capital ratios dropped when inflation and corporate tax rates were high, during WWI and in 1940–1980. The theory can explain the sinking bank capital ratios during these periods, but also their relative stability since the early 1980s. High corporate taxes and inflation were estimated to account for half of the drop in Swedish bank capital ratios since WWII.

Keywords: Bank leverage; Capital-asset ratio; Inflation; Corporate taxes.

JEL-codes: E44; E52; G28; G32; H25; N23; N24

48 pages, November 17, 2005

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