Do Tax Changes Affect Credit Markets and Financial Frictions? Evidence from Credit Spreads

VfS Annual Conference 2016 (Augsburg): Demographic Change from Verein für Socialpolitik / German Economic Association

Abstract: In this paper, we empirically document a link between tax changes and financial market conditions. Using the Romer and Romer (2010) narrative record of exogenous federal tax liability changes for the US, we show that an increase in taxes leads to higher risk premia for corporate bonds issued by financial and non-financial firms. Consistent with recent theories of intermediary asset pricing, we demonstrate that risk premia are driven by intermediaries' balance sheet conditions, which -- according to our results -- are in turn affected by tax changes. Two tax acts are particularly relevant for the transmission of taxes to financial market conditions, namely the Tax Reform Act of 1986 and the Jobs and Growth Tax Relief Reconciliation Act of 2003. Interestingly, none of these two tax acts specifically targeted the financial sector. Therefore, an important implication of our results is that any tax change can potentially spill over to financial market conditions, with the associated consequences for real economic activity.

JEL-codes: E44 E62 G12 (search for similar items in EconPapers)
Date: 2016
New Economics Papers: this item is included in nep-mac and nep-pbe
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Citations: View citations in EconPapers (1)

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Persistent link: https://EconPapers.repec.org/RePEc:zbw:vfsc16:145636

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