How Do Corporate Tax Rates Alter Conforming Tax Avoidance?

Abstract

We examine an international panel of domestic firms to quantify the degree to which conforming tax avoidance changes with statutory tax rates. We derive an estimation method that identifies conforming tax avoidance as a response to variation in tax rates over time and across countries. The estimation method distinguishes this type of response from other responses, such as real effects with changing tax rates. Overall, we find that a 1-percentage point decrease in the corporate tax rate corresponds with a 1.1 percent increase in pre-tax book income in domestic firms, which we interpret as a substantial conforming tax avoidance response by these firms. We further show that these findings are not explained by broader (non-tax) incentives for earnings management, particular countries, losses, intangibles, or short-run intertemporal profit shifting. We identify discretionary cash flows, reserves, and the valuation of inventories as channels for conforming tax avoidance and provide preliminary evidence that this type of activity also plays a role in multinational firms. Overall, our findings imply that there are tax revenue implications of a tax rate cut due to reduced conforming tax avoidance and that conforming tax avoidance might impair the information content of financial statements.

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