McIntire School of Commerce
University of Virginia
Much empirical evidence is consistent with properly incentivized executives engaging in more tax avoidance. However, other studies provide evidence consistent with tax avoidance facilitating managerial rent extraction. We address these mixed results by reexamining some of the earliest empirical evidence that tax avoidance and rent extraction are complementary activities. Specifically, we reexamine the negative relation between executives’ equity compensation and tax avoidance that is concentrated in firms with weaker shareholder rights. Although this pattern of results is consistent with complementarities between tax avoidance and rent extraction, we propose it is also consistent with tax exhaustion theory because the substantial tax benefits from equity compensation reduce firms’ demand for additional tax avoidance. We also draw on recent findings that suggest shareholder rights indices are problematic as a measure of corporate governance in the context of tax avoidance. Our results suggest tax exhaustion is a more compelling explanation for cross-sectional differences in the relation between executives’ equity compensation and tax avoidance. Further, failing to control for tax avoidance opportunities when using shareholder rights indices can confound inferences. Although our analyses do not disprove the notion that managers can use tax avoidance to facilitate rent extraction, they challenge the notion that this behavior is widespread.
Our study evaluates the role of coordination, at both the government- and the firm- level, on the transfer prices set by U.S. multinational corporations (MNCs) when income taxes and duties cannot be jointly minimized with a single transfer price. We find that either the presence of a coordinated income tax and customs enforcement regime or coordination between the income tax and customs functions alters transfer prices for these firms. Our analyses have implications for both firms and taxing authorities. Specifically, our findings suggest that MNCs might decrease their aggregate tax burden by increasing coordination within the firm, or that governments might increase their aggregate revenues by coordinating enforcement across taxing authorities. Our study is novel in that we document, in a specific setting, how coordination influences MNC's tax reporting behavior.
Income shifting from high-tax to low-tax jurisdictions is considered a primary method of reducing worldwide tax burdens of multinational firms. Current losses also affect income-shifting incentives. We extend prior approaches by explicitly considering unprofitable affiliates and test whether the association between losses and tax incentives for unprofitable affiliates deviates from the negative association observed in profitable affiliates. Results suggest that multinational firms alter the distribution of reported profits to take advantage of losses. Our point estimate for profitable affiliates implies that an increase of one standard deviation in the tax incentive, C, of an affiliate with average return on assets of 13.3 is associated with a lower return on assets of 0.5 percentage points. The same change in tax incentive of an unprofitable affiliate is associated with an increase in its return on assets of approximately 0.7 percentage points, holding assets, labor, productivity and other factors constant. We further document a larger responsiveness to tax incentives between profitable and unprofitable affiliates in high-tax jurisdictions, consistent with predictions.
This study investigates the circumstances under which "enhanced relationship" tax compliance programs are mutually beneficial to taxpayers and tax authorities, as well as how these benefits are shared. We develop a model of taxpayer and tax authority behavior inside and outside of an enhanced relationship program. Our model suggests that, despite the adversarial nature of the relationship, an enhanced relationship program is mutually beneficial in many settings. The benefits are due to lower combined government audit and taxpayer compliance costs. These costs are lower because taxpayers are less likely to claim positions with weak support and the government is less likely to challenge positions with strong support inside the program. Further, we show that an increase in the ability of the tax authority to identify uncertain tax positions makes an enhanced relationship tax compliance program more attractive to both the taxpayer and the tax authority.
A firm’s deferred tax position can influence how it is affected by a transition from one tax regime to another. We compile disaggregated deferred tax position data for a sample of large U.S. fi rms between 1993 and 2004 to explore how these positions might affect firm behavior before and after a pre-announced change in the statutory corporate tax rate. Our results suggest that the heterogeneous deferred tax positions of large U.S. corporations create substantial variation in the short-run effects of tax rate changes on reported earnings. Recognizing these divergent incentives is important for understanding the political economy of corporate tax reform.
This study uses a confidential dataset of firms in the Internal Revenue Service (IRS)'s Coordinated Industry Case (CIC) program to examine the effect of audit certainty on taxpayer behavior. We first model the determinants of assignment to the program. Though the ability and incentives to avoid taxes are related to CIC assignment, we find that the IRS targets firms primarily based on size and complexity. We then test whether audit certainty has a significant effect on taxpayers’ initial filing liability (i.e., a deterrence effect), total filing liability (combined effect of deterrence and enforcement), or tax reserves (expected future tax payments associated with positions claimed in the current year). Results suggest that audit certainty alters managers’ expectations regarding future tax payments but does not have significant deterrence or enforcement effects relative to the IRS's standard selection and audit process for large corporations not included in the CIC program. Our paper provides new empirical evidence on the strategic game between the taxpayer and the tax authority and has important implications for tax authorities as they consider the costs and benefits of expensive certain audit programs.
Can financial statement proxies reliably identify tax avoidance? This is an important question because our understanding of the determinants of tax avoidance largely depends on results generated using such proxies. We seed Compustat data with three tax avoidance strategies and test how reliably effective tax rates and book-tax differences identify the seeded tax avoidance. We find permanent tax avoidance is more easily detected than deferral strategies and that financial reporting choices can reduce statistical power. We also conclude that no single proxy most powerfully detects all types of tax avoidance. These findings are robus to changes in assumptions about the magnitude and pervasiveness of tax avoidance in the sample and are validated using a sample of tax shelters. We also offer evidence on how research design choices, firm performance and accounting for tax risk affect power. We contribute to the literature by using a controlled environment to examine the effectiveness of financial statement proxies for tax avoidance.