Discussion of Bilateral Implicit Taxes and AntiCompetitive Banking Regulation

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Discussion of Bilateral Implicit Taxes and
Anti-Competitive Banking Regulation

• David A. Guenther
• 2008 JATA Conference
• February 22, 2008

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Dave? and Terry's? state tax benefits
Terry Shevlin's state tax benefit (0) ?
Dave Guenther's state tax benefit (9) ?
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Paper looks at two tax-related issues

• To what extent are lenders able to capture the
  benefits of borrowers' tax deductions in the form
  of higher interest rates? (does Dave pay more
  than Terry?)
• To what extent are lenders' tax costs (state
  income taxes) passed on to borrowers in the form
  of higher interest rates? (does Dave pay more
  than Terry?)
• Both of these effects are discussed as "implicit
  taxes"
• How has more banking competition changed these
  results?

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Main results

• Robust empirical relation between interest rates
  on home mortgages and
• banks' state effective tax rates
• borrowers' state-specific tax benefits for home
  mortgage interest deduction
• Result is significantly less after legislation
  allows interstate competition among banks
• Impressive set of robustness tests!

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Link between theory and paper's results

• Result intriguing, but I wanted to know
• Are these two effects really part of the same
  underlying phenomenon?
• What theory would explain them?
• Are they implicit taxes?

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Is this one effect or two?

• Incidence of corporate tax if demand is
  inelastic, firms can pass on corporate tax to
  customers in the form of higher price
• Lenders capturing borrowers tax benefits how is
  this different from simple supply and demand? If
  borrowers' cost of something decreases, won't
  borrowers demand more, pushing up price?
• Adding theories from economics could help us
  determine if these effects are the same

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Are both (or either) of these implicit taxes?

• "We use the term implicit taxes to mean the
  variations in the prices of goods and services
  resulting from the taxes on a transaction being
  levied on one or another party to that
  transaction." (p. 1)
• "This is consistent with several papers, such as
  Maydew (2001, p. 396), who states, broadly, '
  "implicit taxes" was popularized by Scholes and
  Wolfson to describe the phenomenon where tax
  favored assets bear lower pretax returns than tax
  disfavored assets.' " (p. 1)

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Theory of tax incidence

• Competitive markets if demand is inelastic,
  corporate income tax can be shifted to customers
  through higher prices
• Monopoly corporate income tax has no effect on
  pricesmonopolist is already maximizing pre-tax
  profits
• Oligopoly ???

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Is pre-1994 banking an oligopoly?

• "We use the term 'contracting power' to stand for
  ... oligopolistic market structure." (p 2)
• "... how the resultant oligopolistic contracting
  power enables banks to favorably shift taxes
  between themselves and the parties they contract
  with." (p 5)
• "consistent with the remaining banking regulation
  being significantly anticompetitive and with
  banks operating in a naturally oligopolistic
  market." (p 33)
• (italics added)

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Tax incidence in oligopolies

• "Unfortunately, there is no well developed theory
  of tax incidence in oligopoly. The reason for
  this embarrassing fact is simple Incidence
  depends primarily on how relative prices change
  when taxes are imposed, but there is no generally
  accepted theory of oligopolistic price
  determination."
• Rosen, Harvey S. (2002). Public Finance. Sixth
  edition. New York McGraw-Hill Higher Education.
• "There is no definitive model of oligopolistic
  behavior, however, and different stories can have
  quite different implications for tax shifting.
  The tendency has been to ignore oligopoly on the
  grounds that 'anything can happen.' "
• Michael L. Katz and Harvey S. Rosen, "Tax
  Analysis in an Oligopoly Model," Public Finance
  Quarterly, vol. 13, no. 1 (1985), pp. 3-20.

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Additional points

• Not clear why shifting of taxes changes with out
  of state bankingisn't mortgage interest income
  taxable to out of state banks?
• If oligopolistic tax shifting, why do interest
  rates go down when state corporate tax rates
  decrease?
• Is there any empirical evidence in the economics
  literature on supply and demand curves for
  mortgages?
• Econometric tests aren't there just 50
  independent observations?

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Conclusion

• A well-crafted empirical study with robust
  results
• My opinion
• the paper demonstrates two separate effects
  rather than two parts of a single effect
• the paper's contribution could be strengthened by
  adding a discussion of economic theories about
  how oligopolies (1) set prices and (2) shift
  taxes to customers
• Is it really necessary to expand the definition
  of implicit taxes?
• Can the paper use differences in state income tax
  rates to explain why Terry gets paid more than I
  do?