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We consider a dynamic model of moral hazard in banking analyzing the implementation of VAT (value-added tax). The bank faces a capital requirement rule. We find that under most stringent regulation, there is less gambling under VAT than exemption but also smaller than efficient. When there is not the most stringent regulation, decreasing tax under exemption in one or both periods decreases banks' incentive to gamble. There is no effect of tax on banks' gambling when the bank faces VAT in both periods. It is possible that the bank increases its incentive to gamble while increasing the requirement rule. Increasing banks' incentive to gamble is more likely the case when there is either exemption in both periods or VAT in both periods. An increase in gambling is less likely when at the same time the implementation of VAT occurs.
