Financial intermediation and the optimal tax system

Abstract

In this paper a stylized general equilibrium model is constructed to analyze the relative efficiency of taxing financial intermediaries. A crucial feature of the model is that tax collection costs are endogenous, i.e. they result from primitive assumptions about information and transaction costs, instead of being assumed ad hoc. The model provides useful insights into the welfare costs and incidence of banks' reserve requirements or, equivalently, of a tax on deposits. In particular, it is shown that a tax on bank deposits can be part of an optimal tax system, provided banks' monopoly power is significant. However, if the banking industry is perfectly competitive, the first dollar of revenue is more efficiently collected by a uniform capital income tax, although a strictly positive welfare loss is incurred.