No. 186: Corporate Tax Planning and Enforcement

This study investigates how strategic interactions between corporate tax planning and tax enforcement are affected by two policy instruments: strengthening tax enforcement by increasing the number or specialization of enforcement staff and improving tax audit technologies. I employ an economic model with a board of directors’ investment in a Tax Control Framework (TCF) and a tax manager’s tax planning effort jointly shaping corporate tax planning and a tax auditor’s technology-based audit decision. I show that the board only invests in the TCF when the enforcement environment is sufficiently strict, because it trades off the costs and benefits of tax planning. Since strengthening tax enforcement decreases tax planning effort, the result can be less investment in a TCF in a strict enforcement environment, implying that TCF investment and enforcement can be strategic substitutes. Strikingly, I identify conditions under which improvements in tax audit technology increase corporate tax planning and impair tax audit efficiency, due to a crowding out of audit incentives. This result contradicts the view that improving audit technologies is universally effective, particularly in tax authorities with adequate or highly specialized staffing.