Does tax enforcement matter for the cost of bank loans? Evidence from the United States

We examine the relationship between the tax enforcement effort of the internal revenue service (IRS) and the cost of bank loans in the US syndicated market. We measure tax enforcement by the rate of IRS audits and find that it decreases bank loan spreads. This finding holds in a series of robustness and sensitivity tests such as the use of alternative IRS tax enforcement measures, instrumental variable regressions, panel data estimations and a quasi-experimental framework of the Section 404b of the Sarbanes-Oxley (SOX) Act. We also find that the negative effect of IRS tax enforcement on loan spreads strengthens for smaller corporations. In addition, we show that stringent IRS tax enforcement decreases the probability that loan contracts will contain covenants. Overall, these findings suggest that banks acknowledge the informational and monitoring role of tax enforcement in the private debt market.