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Home > Journals > Michigan Law Review > MLR > Volume 125 > Issue 3 (2026)

 

Abstract

After the 2008 Financial Crisis, regulators in the United States and abroad enacted a wide range of policies designed to strengthen the financial system. Despite considering several proposed changes to the tax code, lawmakers almost exclusively relied on other regulatory tools. That inaction was a missed opportunity, and the consequences of that oversight persist. Tax policy is an underappreciated dimension of financial regulation. The tax code already promotes financial stability in several important ways, such as by incentivizing banks to build reserves for bad loans and recognize losses on debt securities, and by providing predictable tax treatment during crises. These provisions demonstrate that well-designed taxation can reinforce the goals of traditional financial regulation. However, this Note identifies areas where the tax code pushes banks to engage in behavior at odds with the typical goals of bank regulation. Most prominently, while many lawmakers and scholars want banks to hold more capital, the tax code’s distinct treatment of debt and equity incentivizes banks to issue less. Preferential treatment for securitized assets contributed to the securitization boom in the lead-up to the 2008 Financial Crisis and continues to push risk outside the regulatory perimeter. Additionally, the credit union tax exemption has subsidized the growth of large institutions whose activities are increasingly indistinguishable from those of taxable banks and that operate under a separate regulatory framework that is in some respects less stringent.

These tensions are not inevitable, and this Note argues that bank taxation should be understood and deployed as a financial stability tool. To that end, this Note surveys several proposals that would better align bank taxation and financial regulation. Policymakers should consider three tax-based reforms: an allowance for common equity regulatory capital to reduce the bias against equity issuance, a balance sheet levy on unstable bank liabilities to force large institutions to internalize their systemic risk, and the repeal of the credit union exemption for large institutions to eliminate a competitive distortion that benefits less stringently regulated entities. Finally, this Note addresses a fourth often-discussed proposal, a financial transaction tax, which would likely undermine rather than promote financial stability and should be approached with caution. Financial regulation does not exist in a vacuum. Lawmakers and scholars can and should treat tax policy as an integral component of the financial regulatory agenda.

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