Tax incidence and tax avoidance

Abstract

Economists broadly agree that the economic burden of corporate taxes is not entirely borne by shareholders but also borne in part by employees and consumers. We examine corporate tax avoidance in a setting where shareholders do not bear the entire economic burden of the corporate tax. We show that the relation between corporate tax incidence and corporate tax avoidance depends on the elasticity of labor supply, the productivity of capital relative to labor, and the tax deductibility of labor and capital. These forces operate through two channels (firm scale and input mix), making the actual association between tax avoidance and incidence an empirical question. We find that firms whose shareholders bear less of the economic burden of corporate taxes engage in less avoidance. Our findings suggest that maximizing after-tax profits might entail less tax avoidance if shareholders do not entirely bear the corporate tax burden. In particular, when the incidence of the corporate tax falls on the firm, firms avoid more taxes. This tendency is stronger if firms use a higher level of capital input, if the deductibility of cost of capital investment is limited, if firms have high capital productivity, or if tax enforcement is strong.

Participating Institutions

TRR 266‘s main locations are Paderborn University (Coordinating University), HU Berlin, and University of Mannheim. All three locations have been centers for accounting and tax research for many years. They are joined by researchers from LMU Munich, Frankfurt School of Finance and Management, WHU – Otto Beisheim School of Management, ESMT Berlin, Goethe University Frankfurt and Carl von Ossietzky University Oldenburg who share the same research agenda.