THE MARKET FOR TAX BENEFITS: EVIDENCE FROM LEVERAGED ESOPS

This dissertation utilizes a unique set of data, leveraged ESOPs, to measure precisely the incidence of a debt subsidy and explore the market for tax benefits. Studies of the overall distribution of tax burdens rely critically upon untested assumptions about tax shifting because virtually no data exist to measure the actual incidence of specific taxes. Leveraged ESOPs provide a unique opportunity to document the amount of tax shifting because almost all ESOP loan agreements contain two interest rates that differ solely depending on the tax treatment of the interest income.; This dissertation compares the after-tax yields for the two interest rates for a sample of ESOP loans from 1984 to 1988 and estimates that lenders retain, on average, from 22% to 34% of the tax benefits before considering any incremental costs associated with subsidized ESOP lending. ESOP interest rates average approximately 100 basis points higher than would be expected if all of the tax benefits of the interest exclusion were passed through to borrowers in the form of lower interest rates. Cross-sectional tests suggest that lenders retain part of the tax benefits as compensation for the risk that the maximum statutory tax rate may be reduced. Economies of scale also appear to enable lower interest rates on large ESOP loans because the tax benefits of the interest exclusion increase proportionally with the size of the loan while lending costs remain largely fixed. It is less clear whether there are inelasticities in the supply of ESOP credit.; These results can be interpreted as an indirect measure of transaction costs, i.e., the inducement required by lenders to supply ESOP credit. Additional analysis suggests that ESOP lenders form a tax clientele of banks that currently face the maximum statutory corporate tax rate and have had large tax liabilities in the recent past.