metadata: authors: 0: author: Huizinga,Harry P.
docna: 0: docna: Withholding taxes and international bank
            credit terms
docty: Policy Research Working Paper
subtopic: Tax Administration,Macro-Fiscal Policy,Taxation & Subsidies,Economic Adjustment and Lending,Tax Law,Nonmetallic Mineral Product Manufacturing,Public Sector Economics,Reproductive Health,International Trade and Trade Rules,Family Planning Research,Public Finance Decentralization and
            Poverty Reduction
teratopic: Finance and Financial Sector Development
abstracts: cdata!: This report shows empirically that
            international differences in withholding tax rates are
            indeed largely reflected in bank credit terms. Using a
            sample of 510 loans to 14 debtor nations originated between
            1971 and 1981, the author finds that the developing
            countries have been able to reduce their interest expense by
            an estimated 56 cents for every dollar of tax withheld at
            the source. He concludes that tax treatment in the creditor
            country of interest income from foreign sources probably
            still has an important effect on credit terms. In
            particular, limits on tax credits for foreign-interest
            withholding taxes, as effectively introduced by the 1986
            U.S. tax reform, will probably lead to less favorable credit terms.
repnme: repnme: Withholding taxes and international bank
            credit terms
display_title: Withholding taxes and international
            bank credit terms
listing_relative_url: /research/1991/09/699869/withholding-taxes-international-bank-credit-terms
topicv3: Nonmetallic Mineral Mining and Quarrying
            m1326877 1700,Tax Expenditures m1326898 1122,Trade m1326924 698,Family Planning m1327501 1452,Tax Simplification m1504614 2527
publishtoextweb_dt: 2010-07-01T00:00:00Z
historic_topic: Finance and Financial Sector Development
origu: International Economics Department
no_of_pages: 37
author_keys: 0: author_key: 428580
model_extractions: **Policy, Research, and External Affairs**

<!-- Start of picture text --> eband International Flnance |<br><!-- End of picture text -->

WPS 765

- This paper a product of the Debt and International Finance Division, International Economics Departmentis part of PRE's continuing effort to understand what determines the cost and quantity of commercial bank credit available to developing countries. Copies are available frce from the World Bank, 1818 H Street NW, Washington DC 20433. Please contact Sheilah King-Watson, room S8-040, extension 31047 (32 pages).

Many countries levy withholding taxes on interest payments on international bank loans and ether debt instruments. These withholding taxes can be credited against taxable income in the major creditor nations, such as the United States and the United Kingdom.

estimated 56 cents for every dollar of tax withheld at the source. U.S. banks passed on close to 100 percent of their potential U.S. income tax credits to developing countries by way of lower interest spreads during the go-go lending years of 1976-78.

International bank loan contracts conventionally state the interest rate or spread above the benchmark rate net of withholding taxes. For a given net interest rate, an increase in the withholding tax rate increases the withholding taxes paid in the borrower country as well as creditable in the creditor country. So intemational bank loans become more profitable to the banks the higher the rate of withholding tax imposed by the borrower country.

As banks compete for loans, one expects these institutions to offer low interest spreads to countries that impose high withholding taxes. Huizinga shows empirically that international differences in withholding tax rates are indeed largely reflected in bank credit terms.

Using a sample of 510 loans to 14 debtor nations originated bctween 1971 and 1981, he finds that the developing countries have been able to reduce their interest expense by an The cost of bank credit to developing countries is made unstable, however, as loan spreads reflect the cyclical marginal value of tax credits to the commercial banks. In particular, tax credits were fully reflected in loans with maturities of four years or less, but only partially in longer-term loans. The rationale appears to be that banks have doubts whethcr tax credits flowing from long-tenm loans will still be allowed in the future. They may also doubt whether they will have enough taxable incorne to actually realize the full tax savings offered by the tax credit.

Huizinga concludes that tax treatment in tlhe creditor country of interest income from foreign sources probably still has an important effect on credit terms. In particular, limits on tax credits for foreign-interest withholding taxes, as effectively introduced by the 1986 U.S. tax refonn, will probably lead to less favorable credit tenns.

The PRE Working Paper Scrics disseminates the findings of work under wa) in the Bank's Policy, Rescarch. and Extemal Affairs Complex. An objectiveofthescries is to get these findings out quickly, evcn if prescntations arc lcss than fully polishie(l. The findings, intcrpretations, and conclusions in these papers do not nccessarily represent official Bank policy.

Produced by the PRE Dissemination Centcr
# Withholding Taxes and International Bank Credit Terms

by Harry Huizingal Table of Contents

|1.<br>Introduction|1|
|---|---|
|2.<br>The Determination of Loan Spreads|4|
|3.<br>The Data and Empirical Results|9|
|3.1 The Data<br>3.2<br>Empirical Results|9<br>11|
|4.<br>Conclusions|15|
|Appendix: Description of Data Sources|18|
|References|20|
|Tables|22|
|Endnotes|32|

* This research was conducted while the author was a consultant at the Debt and International Finance Division, International Economics Department of the World Eank. The author thanks participants of the Tax Discussion Group at Stanford Law School, particularly Joe Bankman, for helpful comments.
# 1. Introduction

Many countries levy withholding taxes on<sup>interest payments on</sup> international bank loans and other<sup>debt instruments. These withholding taxes</sup> can be credited against taxable<sup>income in the major creditor nations, such as</sup> the United States and the United<sup>Kingdom. International bank loan contracts</sup> conventionally state the interest<sup>rate or spread above the benchmark rate net</sup> of withholding taxes. For a given<sup>net interest rate, an increase in the</sup> withholding tax rate increases the<sup>withholding taxes paid in the borrower</sup> country as well as creditable in<sup>the creditor country. Hence, international</sup> bank loans become more profitable<sup>to the banks the higher the rate of</sup> withholding tax imposed by the borrower<sup>country. As banks compete for loans,</sup> one expects these institutions to<sup>offer low interest spreads to countries</sup> that impose high withholding taxes.<sup>This paper shows empirically that</sup> international differences in withholding<sup>tax rates indeed to a large extent</sup> are reflected in bank credit terms.

Using a sample of 510 loans to 14<sup>debtor nations originated during the</sup> years 1971-1981, we find that the developing<sup>countries have been able to</sup> reduce their interest expense by an estimated<sup>56 cents for every dollar of</sup> tax withheld at the source. U.S. banks<sup>are shown to have passed on close to</sup> 100 per cent of their potential U.S. income<sup>tax credits to developing</sup> countries by way of lower interest<sup>spreads during the go-go lending years of</sup> 1976 to 1978. In particular, tax<sup>credits are shown to be fully reflected in</sup> loans with maturities of four years or less,<sup>but only partially in longer</sup> term loans. The rationale appears to be that<sup>banks have doubts whether tax</sup> credits flowing from long term loans will still<sup>be allowed in the future, and</sup> they may doubt whether thev will have sufficient<sup>taxable income to actuallv</sup> 1
realize the full tax savings offered by the tax credit.

Bank valuation of potential tax credits varies with the business cycle, as bank taxable income is very cyclical. During recessions potential tax credits are not valuable to the banks as they are not very profitable. and thus onie expects interest spreads not to reflect international differences Ln withholding tax rates. Indeed, interest spreads are shown to be invariant to withholding tax rates after the two oil crises during the years 1975-1976 and again during 1980-1981. At the same time, tax credits were in large measure reflected in interest spreads around 1978, as creditor economies recovered after the first oi.l shock. The apparent countercyclicality of the cost of bank credit to developing countries has proven to be a destabilizing factor in the flow of funds to developing countries.

The academic literature has almost completely ignored the impact of creditability of withholding taxes on bank credit terms. Lindert [19891, for example, computes the realized return on international bank loans to developing countries as of 1986 without taking into account the creditability of interese withholding taxes, thus severely underestimating the true returns to these loans. Frankel (1984, 1985], however, points out the role of the interest tax credit in banks' asset allocation choice, and in the pricing of loans.

The tax credit gives countries the obvious incentive to increase the withholding tax rate, but this does not appear to have happened on a large scale. In a more subtle way, governments have attempted to borrow indirectly through private banks or enterprises that are subject to the withholding tax. This enables the creditor bank to obtain the creditor country tax credit, and to lend at a lower net interest, to the benefit of the borrower country.

2
Frankel [1985, p. 5] points out that developing countries, and in particular Brazil, have reacted by directly or indirectly offering withholding tax rebates to private borrowers, thus ensuring tax credit induceA spread discounts while minimizing the impact of the withholding tax on domestic borrowers. In response, creditor governments have acted to limit the creditability of interest withholding taxes. The United Kingdom, for instance, limited the creditability of Brazil's withholding tax to 15 per cent in 1982, while Brazil's withholding tax rate was 25 per cent. The 15 per cent limit now applies to all countries.1 The U.S. has responded, in the Tax Reform Act of 1986, by forcing banks to allocate their foreign source income into essentially three separate baskets and to calculate the foreign tax credit separately for each of the three baskets.<sup>2</sup> The three baskets are (i) financial services income, (ii) high withholding tax interest income, and (3) dividend income paid by non controlled foreign corpo: :tions. High withholding tax interest is gross Lnterest taxed at a withholding tax rate of 5 per cent or more. Low witnholding tax interest income, which is the remaining interest income, is included in the financial services income basket. Excess tax credits may be carried forward seven years or back two years to reduce taxes on income in the same basket. The effect of this legislation has been to disallow U.S. banks to use credit for high withholding taxes to reduce the U.S. tax on the banks' low withholding tax interest income and income from financial services.

Ironically, the 1986 tax reform almost coincided with the launching of the Baker plan for dealing with third world debt in 1985. The plan called for continued voluntary bank lending to the developing countries at almost 3
the same time that the tax incentives for such lending were reduced. A lesson for the future may be that tax incentives for capital flows to developin" countries in various kinds should be in line with or at least not undermine stated policy objectives regarding these flows.

The remainder of this paper is organized as follows. Section 2 describes the banks' international lending decision and derives the estimating equation. Section 3 discusses the data and presents the empirical results. Section 4 concludes.

# 2. The Determination of Loan Spreads

Following Feder and Just [1977], several authors have investigated to what extent country risk factors are reflected in the spread over Libor charged on international loans. Edwards [1984] shows that the spreads of loans to developing countries during the period 1976-1980 are positively related to the country's debt co output ratio. Ozler [1988] shows that LXC loan spreads also reflect payments problems in earlier periods. Ozler [forthcoming] arguss that the downward trends in spreads during the 1970's are consistent with gradual learning by the commercial banks about a country's creditworthiness. This section extends the empirical framework to take account of the impact of withholding taxes on interest spreads.

Credit terms in international loan contracts can be on a net or a gross basis. Net loan contracts specify the interest payments the bank receives net of withholding tax, while a gross loan contract states the interest payment to the creditor subject to the withholding tax. Obviously, with gross contracts, the net interest payments out of the country can be rather risky, as they are subject to unforeseen changes in the withholding tax.

4
Until the mid 1970's, the Internal R'evenue Service did not allow a U.S. tax credit for foreign tax withheld on net loans, as it was argued that the interest tax was paid by the borrower and not by the U.S. bank. Until then U.S. banks had an i-centive to write gross loan contracts, even though such loan carried a risk of higher future withholding taxes. Starting in the mid 1970's, however, the Internal Revenue Serv.ce recognized withholding tax credits for all international loans and the incentive to write gross loans disappeared. Overall the banking convention has been to write net international loan contracts.

Let i be the net interest rate in an international loan contract, and let r be the rate of withholding tax levied by the borrowing country. The gross interest rate is then i/(l-r), and the tax withheld per dollar of debt is i7/(l-r). Withholding tax rates on interest typically range from 0 to 30 per cent, while corporate tax rates in the major creditor countries are at least 30 per cent. This suggests that banks would never be in an excess credit position.<sup>3</sup> However, this is not the case as creditor and borrower country definitions of income typically differ. In particular, the withholding tax is imposed on all interest income, while the creditor country taxes interest income net of interest expense and maybe some other bank - - expenses. As an example, let r 0.20, i 0.10, and let the bank's cost of funds, denoted i*, be 0.08. The gross interest rate is 0.125 (from - 0.10/(1.0 0.2)). Per dollar lent, the tax withheld by the borrowing - country is 0.025 (from (0.10*0.20/(1 0.20)). Income by creditor country definition is 0.045 per dollar lent. Hence, the effective borrowing country tax - by creditor countrv definition - is 56 (from 0.025/0.045) per cent rather than 20 per cent. This means the bank may well be in excess credit 5
position, as 56 per cent exceeds, for instance, the U.S. corporate tax rate. For a bank in excess credit, let Oi(r/l-r) be the actual value of the Lax credit to the bank measured in before tax income per dollar of debt. Hence, the effective gross interest rate the bank receives is i(l[ + 0(v/l.r)]. With e - l., the bank can take the full tax credit. In this instance, the marginal creditor country income tax is the creditor country corporate tax rate. This tax rate, however, does not affect the interest rate i as we assume the bank's cost of funds can be fully expensed against creditor country taxable income. With P < 1, the bank cannot take the full credit and the bank is in an excess credit position. Now the marginal creditor country incom' tax is zero.

The size of _A_ increases with the creditor country tax rate, if in fact the bank is in an excess credit position. This is the case as for a bank in an excess credit position the U.S. tax liability on foreign source income is a binding constraint on the actual tax credit taken. Hence, an increase in the U.S. tax rate that relaxes this constraint increases the share of the potential tax credit that is actually taken. Similarly, e decreases with the withholding tax rate. However, the magnitude of 8 in practice does not follow just from the tax details of a specific loan. Rather, the extent to which the potential tax credits associated with a certain loan can be used cepends on the availability of other lower withholding tax income and other bank income for which creditor country taxes can be offset by the credit. In particular, d will be larger the more profitable a bank's general operations in the foreign source from which the interest originates. U.S. tax changes introduced in 1986 that compelled banker to calculate tax credits for separate baskets of income effectively reduced .

6
Unen setting loan spreads, banks take into account futurs tax credits as well as risk factors that affect the probability of loan default. Let p stand for the probability of loan default. For simplicity, we assume that in case of default the bank is not repaid at all. Banks are assumed to be risk neutral. Bank rivalry ensures that the bank's expected return - inclusive of the tax credit - equals the bank's cost of funds. Formally, the loan interest rate is determined such that In the empirical section, the bank's cost of funds will be taken to be the London Interbank Offer Rate (LIBOR). The above formulation implies full loss offset of lost principal in case the country defaults and the bank faces a positive marginal creditor country corporate tax rate. Relationship (1) may not simultaneously hold for all banks in all countries or even the same country. Rather, the banks that can make the most of the credit, and thus have the highest P, will make the loan and determine the interest rate i.4 The probability of default generally is assumed to depend on country as well as loan characteristics. Variables that have been considered good indicators of creditworthiness include the country's debt service to exports ratio, and debt to gnp ratio. Loan characteristics that may influence default are the size of the loan and loan maturity. The probability of default can also be expected to be related to the bank's required rate of return i*, as it affects i and as high interest charges make loan default more likely. The probabilicy of default is posited to have the following particular functional form 7
where xi is a default risk factor other than<sup>the interest</sup> rate i. From (1) and (2) we can derive the following expression where Thus S is the contractual interest spread, i - i*, divided by the bank's cost of funds i*. Linearizing (3) around r - 0 and - 1 yields 1 where The equation that is actually estimated is where a is a constant and e if is a random disturbance.5 As pointed out, not all tax credits can be used if the banks has 8
insufficien **t** axable income. The above basically single period specification abstracts from the fact that, for instance in the United Statrs, banks that do not have sufficient current taxable income are allowed to carry credits backwards two years, and to carry them forward for seven years. Under current rules, banks can only carry credits forward to reduce future taxes on income in the same basket. Clearly, postponing taking the credits reduces their present value. Also, what is important in this regard is the availability to banks of other ways to shelter income. As pointed out by Frankel [1985], banks were allowed to deduct interest expenses incurred to carry tax-exempt bonds from taxable income during the period under consideration. Hence, foreign tax credits may not have been of immediate importance for the U.S. banks. In a world of income and regulatory uncertainty, the value of tax credits and hence of the parameter 6 is to some extent determined by their option value rather than by their immediate usefulness.6

# 3. The_ ata and Empixical Results

## 3.1 The Data

The data -,et consists of 510 loans originated during the period 19711981, from the World Bank's Debtor Reporting System. All loans are to the private sector, which surely pays the withholding tax, are denominated in U.S. dollars and specify the interest spread above LIBOR. For each loan we know the month of origination, the month of maturity, the loan amount, the debtor country, and the creditor country. Some loans are listed as multiple creditor loans. On a loan by loan basis, we collected the relevant interest withholding tax rates, taking note of bilateral tax treaties between debtor 9
and credit nations (see the Appandix for data sources). Multiple creditor loans are included if the debtor country imposes a uniform withholding tax rate on all outgoing bank interest payments.

Table 1 breaks down the loans by year of origination, and provides information on average interest spreads and withholding taxes for loans originated during the year. Spread is the spread above LIBOR written into the loan contract, while the variable S is constructed as this contractual spread divided by the 6-month LIBOR rate during the month of loan origination. The LIBOR rate proxies for the bank's cost of funds i*. Note that 166 of the loans were contracted in the years 1977 and 1978 alone. Note also that the average withholding tax rate has tended to fall over time. This trend is not the result of tax rate reductions in the borrower countries. Rather, countries with high withholding taxes, such as Brazil, were able to borrow in the early 1970's, while other countries had to wait till the mid and late 1970's to gain access to international bank credit. Also note the countercyclical pattern in the spread and S variables: they are low before and rise after both the 1973 and 1979 oil crises.

Table 2 provides summary data on loans for each of the 14 borrower countries in the data set. Among the major borrower countries, Korea and Mexico, with high withholding tax rates, generally received low spreads.

Chile, Costa Rica and Honduras, with lower than average tax rates, contracted higher than average spreads. Brazil, with a high withholding tax rate of 25 per cent, received an average spread somewhat above the overall sample mean of 1.51, perhaps reflecting non-tax risk factors.

Table 3 breaks down the set of loans by creditor country. The major creditors are the United State and the United Kingdom with, between the two, 10
275 loans. The United Kingdom overall has provided loans with a lower than average spread to countries with higher than average tax rate. U.S. banks have provided relatively many loans to low tax countries, such as Costa Rica, Chile, and Honduras, as shown by a low average tax of 13.38 for U.S. loans, below the overall sample mean of 17.98. To some extent this may reflect the non-creditability of with;.olding takes on net loans till the mid 1970's.

Table 4 provided summary statistics for the spread and tax variables and the creditworthiness indicators for the whole sample. The first column states the means and standard derivations of the xi variables, while the second column gives these statistics for the zi. Average debt to GNP ratios for all loans are a modest 0.22 during this period of loan contraction. The loan amount, in billions of U.S. dollars, and loan maturity are the only loan specific variables. All other variables are country risk variables at the time of loan origination. Specifically, the debt and debt service variable are for the country as a whole. Note that in the 1970's and early 1980's, average debt service to exports already stood at a high 91 per cent. The table does not reflect that during the period average maturities substantially lengthened, as more and more loans were refinanced.

# 3.2 Empirical Results

The results of regressions of equation (4) are reported in Table 5. The first two columns include all 510 loans. The coefficient on the Tax variable shows that 56 per cent of creditor country tax credits are reflected in international credit terms. All controls, apart from the loan amount, are strongly significant. The ratio of imports to GNP enters negatively, which suggests that a countrv's openness helps to provide better international credit terms. Oddly, high inflation countries received better credit terms 11
than low inflation countries. This could reflect the perceived salutary impact of high seigniorage tax revenues on the national budget. The debt service to exports variable enters negatively, and may indicate bankers' throwing good money after bad. Ex post. we know that bankers made some unwise credit decisions, and these regressions to some extent appear to confirm this. Columns 3 and 4 only present results for the sample of loans from only U.S. banks. Fully 79 per cent of tax credits are shown to have been passed on to the debtor nations in the form of lower spreads. Results for the sample of U.K. loans, in columns 5 and 6, show a smaller tax effect of 43 percent.

Overall, the results indicate credit terms significantly reflect tax withholding tax rates. This tax effect is stronger for U.S. loans than for the general sample. This suggests lenient awarding of tax credits in the U.S. has caused international interest rates spread to fall to reflect tax credits rather than vice versa.

As pointed out, there was an important regime change when the Internal Revenue Service started recognizing the creditability of withholding taxes for net loans in the mid 1970's. As a result, the U.S. relative share of the international loan market increased in the late seventies: in the years 1976-1978 the U.S. awarded 52 per cent of its loans in the data set, while other countries made only 38 per cent of their loans. Table 6 provided estimates of the tax effects for U.S. and non-U.S. loans for this period of heavy U.S. lending. The tax effect for U.S. loans for this period at -0.924 indicates almost a full pass through of tax credits to borrowers. During this period, non-U.S. lenders were relatively uncompetitive, as they discounted only 61 per cent of potential tax credits. Regressions for the 12
years 1979-1981, also in the table, show that the- tax effect disappears for U.S. loans, and is reduced to around 21 per cent for non-U.S. loans. The vanishing tax effect for U.S. loans cannot be due to a change in the tax law, as at that time there had not yet been substantial changes in U.S. tax regulations. Of course, the effect to some extent may be due to rumblings of future changes. More likely, the tax effect declined in importance because (i) banks already had accumulated huge potential tax credits and (ii) in the wake of the second oil crisis bank taxable income was declining.

To explore the latter explanation further, Table 7 reports regression results for different time periods of loans origination for all creditors. The four periods roughly correspond to the periods leading up to and following the oil crises of 1973 and 1979. The actual years these oil crises arose were included in the pre-oil crisis periods, as bank taxable income can be assumed to respond with a lag to a downturn of the economy. Regardless of the exact cut-off points of the specific periods, what emerges is the result that the tax effect on interest rate spreads basically disappeared in the years following each of the two oil crises. Apparently, in those years banks did not value the prospect of tax credits, as taxable income was sufficiently sheltered either because there was no taxable income or because other sheltering methods were sufficient.

To support this, Table 8 provides same data on U.S. bank profitability and taxes for the years 1970-1985. In particular, the table provide data on gross income as a percentage of total assets, and of U.S. tax liability as a percentage of gross income for all banks traded on the New York Stock Exchange, and separately for the top 10 U.S. banks. The table shows that both measures were relatively low during the years 1973-1974 in the wake of 13
the first oil shock. Profitability and taxes then reached highs around 1978, and dropped off again in 1981. In particular, the average tax rate for the top 10 banks dropped from 35.72 in 1980 to 29.86 in 1981. Table 1 and 8 together indicate a negative correlation between the average U.S. tax rate paid by U.S. banks and the net interest charged on loans to developing countries.

The important implication is that credit supply to the developing countries is highly unstable. In times of world recession, cheap loans to developing countries tend to dry up, as banks do not need additional tax shelters. This scenario of unstable credit supply to developing countries, which in part caused later payments difficulties, has been described in detail by Devlin [1989]. Devlin argues that the unstable credit supply is due to shortcomings in risk assessment and particular characteristics of the banking industry, such as the relationship between lead banks and participating banks in loan syndicates, rather than due to external incentives provided to the banking industry in the form of, for instance, withholding tax credits.

By lending internationally, banks obtain the option to use tax credits for the duration of the loan, and for some time thereafter as tax credits in, for instance, the United States can be carried forward for seven years. Banks can be expected to value tax credits arising from short term loans close to one for one, as only banks that will surely use them will obtain them. Also, for short term credits there is little risk of an unforeseen changes in tax regulation. To test this, we estimate the tax effect for sets of loans of different maturities.

The results, in Table 9, show that for loans with maturities equal to or 14
less than 2 or 4 years the hypothesis that P - 1 cannot be rejected at the 5 per cent significance level. Generally, the longer loan maturities, the smaller the tax factor in the determination of loan interest spreads. For loans with a maturity of 9 or more years, there is no discernible tax effect at all. These results indicate that to maximize its tax credit related discounts, a country should obtain short term credit that are continually refinanced with possibly different banks. However, this effect should be balanced against the strong and independent negative impact of loan maturity on the interest rate spread that is evident in Table 5, and is confirmed throughout.

# 4. Conclusions

This paper has shown that tax credits available to creditor banks for withholding taxes paid in the developing country to a large extent are reflected in lower international interest rate spreads. Variation in the value of these tax credits has contributed to the variability of credit terms offered to developing countries during the 1970's and early 1980's.

Specifically, the avalanche of credit that became available in the years 1977 and 1978 appears in important part due to (i) a surge in bank taxable income in need of a tax shelter and (ii) a shift in International Revenue Service policy which allowed the creditability of withholding taxes for net loans. These reasons for the credit surge are in addition to the standard explanation that at the time the banks were awash with deposits from the oil exporting countries.

In the period 1980-1081, international interest spreads do not reflect sizable tax credits. Apparently, the marginal value of obtaining additional 15
means of sheltering tax income was very low for the banking industry at that time. This may have contributed to the banks' refusal to simply refinance the old debt at comparable terms in the latter part of 1982 that set off the debt crisis of the 1980's. The build-up of debt by that time may have made a debt crisis inevitable. However, the low value of tax credits to the banks was one of the factors that caused the debt crisis to start in 1982, in addition to a restrictive macro policy in the U.S. that resulted in high real interest rates and a deep recession.

The value of tax credits of U.S. banks has been substantial. In 1976 and 1978, for instance, the respective values were $212.6 and $277.0 million.<sup>8</sup> These tax credits have to be added to interest payments by the country to get a fair picture of the true return of international lending to U.S. banks, and they make the banks appear less short-sighted than they are sometimes made out to be. These tax benefits are in addition to the substantial benefits of deposit insurance, which as argued by Penati and Protopapadakis (1988] is a major subsidy to international lending. Ozler and Huizinga (1989] show that the benefits of present federal deposit insurance are reflected in secondary market prices of LDC debt. Of course, secondary market prices of LDC debt and bank stock price should also reflect the creditability of withholding taxes, to the extent that the borrowing public and private entities are subject to these taxes.9 The creditability of withholding taxes should have affected international interest rates during the 1980's and 1990's as well, to the extent that recent regulations allow the creditability. Of course, interest rates on bank loans to developing countries during the 1980's to a large extent are the result of reschedulings of previously contracted debt. Thus 16
these interest rates are the outcome of complex bargaining between the banks and the developing countries, with the withholding tax creditability as only one of the determining factors. The impact of tax regulations on rescheduling agreements have at this point not been explored.

17
Appendix: DescriRtion of Data Sources.

The "Jorld Bank's Debtor ReRorting System provides the following inforaation on a loan by loan basis: debtor country, creditor country, month of loan origination, month of loan maturity, loan amount, and the interest rate spread. The selected loans are to the private sector, denominated in U.S. dollars, and specify the spread above LIBOR. Some loans with multiple creditor countries are included in the sample if the debtor country imposes a uniform interest withholding tax on all outgoing bank interest payments.

Information on the country's debt outstanding, and debt service are derived from the Debtor ReDoQting System as well.

Tax rates are compiled from the following sources: Comnorate Taxes. A Worldwide Summary (previously called CorDorate Taxes in 80 Countries), Price Waterhouse (New York), various issues.

International Tax Summaries, Coopers and Lybrand (Wiley, New York), various issues.

Country information and tax treaty information from the following publications of International Bureau of Fiscal Documentation in Amsterdam: African Tax Systems, Looseleaf, E. de Brauw-Hay and F. Butzelaar-Mohr, editors.

Taxation in Latin AmerLca, Looseleaf, P. Masson-Parodi, editor. Taxes and Investment in_Latin America, Looseleaf, J. van Hoorn, Jr., editor.

For some years, tax data has been interpolated or extrapolated, as tax rate information is not available for all years for all countries. However, tax rates, and especiallv internationally negotiated tax rates, tend to vary little from year to year.

18
All other data is from the IEC, the World Bank. Data for Gross Domestic Product is used instead of data for Gross National Product if the latter is not availZble.

19