Impact of Fiscal Policy on Financial Intermediaries and Asset Prices

Federico Mainardi, Joint Program in Finance and Economics PhD Student

Over the last fifty years, the U.S. financial system has witnessed deep structural changes in the distribution of assets across financial intermediaries with pension funds being gradually replaced by mutual funds, insurance companies and ETFs. Despite this strong pattern and the growing evidence highlighting the importance of institutional investors for financial fluctuations, the asset pricing literature lacks a unifying explanation behind the origin and growth of heterogeneous financial intermediaries. The objective of this paper is to fill this gap by studying the role of fiscal policy as a first-order driver of the changes in the institutional structure observed in the U.S. financial system. I show that fiscal reforms that alter the tax status of specific financial intermediaries are followed by quantitatively large redistribution and, in absence of a supply response, by an increase in the cost of tax-advantage financial products. Using micro-level data, I further show large heterogeneity in the response to tax incentives across the wealth distribution.