Multinational firms can avoid taxes through structured transactions among different jurisdictions (e.g., Rego 2003), such as reallocating taxable income from high-tax jurisdictions to low-tax ones (Collins et al. 1998). This type of income shifting significantly reduces tax revenues of governments in high-tax jurisdictions and potentially hinders domestic economic growth and other social benefits (e.g., GAO 2008; U.S. Senate 2006). Policy makers around the world, including the United States, European Union, and Canada, have either enacted or are considering regulations related to multinational firms’ cross-jurisdictional income shifting and tax avoidance behavior. However, relatively little is known about multinational corporate tax avoidance behavior (Hanlon and Heitzman 2010), though such knowledge provides a basis for making and enforcing related rules. Further, the relation between firms’ tax avoidance and financial disclosures is not well established. In our paper, Tax Avoidance and Geographic Earnings Disclosure, forthcoming in the Journal of Accounting and Economics, we investigate how geographic earnings disclosure in firms’ financial reports relates to multinational firms’ tax avoidance behavior.
Posts Tagged ‘Taxation’
In our paper, Innovation, Reallocation, and Growth, which was recently made publicly available on SSRN, we build a micro-founded model of firm innovation and growth, enabling us an examination of the forces jointly driving innovation, productivity growth and reallocation. In the second part of our paper, we estimate the parameters of the model using simulated method of moments on detailed U.S. Census Bureau micro data on employment, output, R&D, and patenting during the 1987-1997 period.
Our model builds on the endogenous technological change literature. Incumbents and entrants invest in R&D in order to improve over (one of) a continuum of products. Successful innovation adds to the number of product lines in which the firm has the best-practice technology (and “creatively” destroys the lead of another firm in this product line). Incumbents also increase their productivity for non-R&D related reasons (i.e., without investing in R&D). Because operating a product line entails a fixed cost, firms may also decide to exit some of the product lines in which they have the best-practice technology if this technology has sufficiently low productivity relative to the equilibrium wage. Finally, firms have heterogeneous (high and low) types affecting their innovative capacity—their productivity in innovation. This heterogeneity introduces a selection effect as the composition of firms is endogenous, which will be both important in our estimation and central for understanding the implications of different policies. We assume that firm type changes over time and that low-type is an absorbing state (i.e., high-type firms can transition to low-type but not vice versa), which is important for accommodating the possibility of firms that have grown large over time but are no longer innovative.
There has been a recent surge in research that seeks to understand the sources of variation in tax avoidance (e.g., Shevlin and Shackelford, 2001; Shevlin, 2007; Hanlon and Heitzman, 2010). The benefits of tax avoidance can be economically large (e.g., Scholes et al., 2009) and tax avoidance can be a relatively inexpensive source of financing (e.g., Armstrong et al., 2012). However, aggressive tax avoidance may be accompanied by substantial observable (e.g., fines and legal fees) and unobservable (e.g., excess risk and loss of corporate reputation) costs. Although understanding the factors that influence managers’ tax avoidance decisions is an important research question that has broad public policy implications, relatively little is known about why some firms appear to be more tax aggressive than others.
In our paper, Corporate Governance, Incentives, and Tax Avoidance, which was recently made publicly available on SSRN, we examine whether variation in firms’ corporate governance mechanisms explains differences in their level of tax avoidance. We view tax avoidance as one of many investment opportunities that is available to managers. Similar to other investment decisions, managers have personal incentives to engage in a certain amount of tax avoidance that may not be in the best interest of shareholders, thereby giving rise to an agency problem. From the perspective of the firm’s shareholders, unresolved agency problems with respect to tax avoidance can manifest as either “too little” or “too much” tax avoidance. As with other agency problems, certain corporate governance mechanisms can mitigate agency problems with respect to tax avoidance.
In our paper, Manager-Shareholder Alignment, Shareholder Dividend Tax Policy, and Corporate Tax Avoidance, which was recently made publicly available on SSRN, we move away from equity compensation as a measure of manager-shareholder alignment and exploit a unique setting exogenous to the firm to assess the effect of manager-shareholder alignment on corporate tax avoidance. Our setting capitalizes on variation in the value to shareholders from corporate tax avoidance, which is driven by a country’s shareholder dividend tax policy. Firms in the United States, such as the ones examined in the prior literature, are subject to a classical tax system. Corporate earnings are taxed at the firm level and then again at the shareholder level when they are distributed as a dividend (i.e., double taxation). Therefore, corporate tax avoidance increases after-tax cash flows creating either more private benefits for managers or higher after-tax cash flows to shareholders. Other countries around the world employ an imputation tax system. In contrast to a classical system, an imputation system imposes taxes on corporate earnings at the firm level, but these corporate taxes paid are credited against the shareholders’ taxes when earnings are distributed as dividends. This credit causes the total tax paid on earnings to be equal to the shareholders’ tax (i.e., single taxation), so corporate tax avoidance increases after-tax cash flows available for managers’ private benefits but does not increase the after-tax cash flows to shareholders. Because corporate tax avoidance is costly, it actually reduces the after-tax cash flows to shareholders under an imputation system and makes them worse off.
The graduated corporate rate structure was publicly promoted as a tax on “bigness” when President Franklin D. Roosevelt first introduced it in 1935. In proposing the graduated rates, Roosevelt explained “[t]he advantages and the protections conferred upon corporations by Government increase in value as the size of the corporation increases . . . it seems only equitable, therefore, to adjust our tax system in accordance with economic capacity, advantage and fact. The smaller corporations should not carry burdens beyond their powers; the vast concentrations of capital should be ready to carry burdens commensurate with their powers and their advantages.” Given the relatively modest graduation in the original rates, however, this move is often portrayed as largely a political ploy rather than a serious tax measure. Paul Conkin noted that the 1935 tax bill in which the graduated rates were imposed “neither soaked the rich, penalized bigness, nor significantly helped balance the budget.” Even at the time its opponents called it a “legislative absurdity” enacted on the “whim” of the President. The conventional wisdom is that the graduated corporate income tax structure was designed to appeal to populist voters as part of the “rhetoric and psychological warfare” of New Deal-era politics, but was not designed to actually change the economics of operating businesses through large corporations. At best, it has been characterized as “an aid to small business.”
In the current environment and in the wake of Dodd-Frank (and, before that, TARP) mandated rules requiring shareholder advisory votes on executive compensation, shareholder-plaintiffs have more aggressively challenged executive compensation decisions. In recent months, an active plaintiffs’ bar has filed a series of cases, which generally fall into three broad categories:
- “say-on-pay” litigation;
- litigation relating to annual proxy disclosure, particularly with respect to equity compensation plans and say-on-pay proposals; and
- litigation relating to Section 162(m) of the Internal Revenue Code.
While most of these challenges have failed on substantive or procedural grounds or both, some have been more successful, and the plaintiffs’ strategies continue to evolve. Notably, even unsuccessful claims can result in costly disruptions and/or reputational harm, especially where injunctions against annual shareholder meetings are threatened.
In this memorandum, we:
On December 21, 2012, the Italian Parliament approved the budget law for 2013 (the “Budget Law”) contemplating, among other things, the introduction of a new tax applicable to certain financial transactions (the “Financial Transaction Tax” or “FTT”).
While the Budget Law includes an articulate regime of the FTT, ”some of its features will be set with a Ministerial Decree to be issued by the Ministry of Economy and Finance (the “Ministerial Decree”) within 30 days from the entry in force of the Budget Law (which is subject to its publication in the Official Gazette, expected to occur in the coming days).
Amid the current debate over tax policy in Washington, there is a bipartisan consensus on one issue: the corporate tax rate, which is currently 35 percent, should be reduced to roughly 25 percent. At the same time, budgetary pressures preclude any significant increase in the deficit to accomplish corporate tax reform.
In light of these competing demands, most corporate tax reformers advocate broadening the corporate tax base to pay for any rate reduction. Unfortunately, few politicians have put forth base-broadening measures that would generate revenue sufficient to significantly lower the corporate tax rate on a revenue-neutral basis.
In fact, revenue-neutral corporate income tax reform is likely to be very difficult, because corporate tax expenditures represent a relatively small portion of total corporate tax revenues. A preliminary analysis by the Joint Committee on Taxation suggested that the elimination of all corporate tax expenditures—except for the deferral of tax on foreign source profits, a provision whose repeal would be politically and economically infeasible—would allow for the corporate tax rate to be reduced to only 28 percent.
Therefore, if policymakers want to reduce the corporate tax rate on a revenue-neutral basis, they will likely have to adopt other types of reforms to broaden the corporate tax base. Ideally, those reforms should offer the potential for significant revenue gains and reduce economic distortions.
Early corporate law scholarship argued both that anti-takeover devices are inefficient (they reduce the value of the firm) and that firms adopt efficient governance terms before they make their initial public offering. Some of this scholarship asserted that firms go public without anti-takeover devices and adopt them later when agency costs are higher. However, subsequent research revealed that most firms adopt anti-takeover devices before completing their initial public offerings. For example, over eighty-six percent of firms that have gone public in 2012 have a staggered board of directors, and both Google and Facebook chose dual-class capital structures that allow the founders to retain voting control disproportionate to their economic stake.
The literature offers a number of explanations for this apparent puzzle. Capital market imperfections may prevent initial public offering prices from reflecting differences in corporate governance terms. Firms may choose inefficient terms due to bad legal advice or because of frictions in the market for financing prior to the initial public offering. Anti-takeover protections could be efficient after all, at least for some firms, because they correct for myopic investors or some other problem. Finally, managers may choose anti-takeover provisions to signal something about their firms. In an essay forthcoming in the Journal of Corporation Law I offer a very different explanation, one based on the tax code.
My argument begins with a variant of one of the existing explanations for anti-takeover protections. The heart of the argument is that managers are not driven solely by a desire for material gain but derive some happiness or utility from the control they exercise over their firm. To the extent that managers derive happiness from control, they may not choose governance terms that maximize the dollar value of the firm. However, unless there is some contracting failure, they will still choose efficient terms — terms that maximize the total value of the firm (the dollar value plus the control value).
My recent article, Mutual Fund Sales Notice Fees: Are a Handful of States Unconstitutionally Exacting $200 Million Each Year?, forthcoming in the Hastings Constitutional Law Quarterly, describes the political compromise struck in 1996 between Congress and state securities regulators. That year, Congress enacted the National Securities Markets Improvement Act of 1996 (NSMIA), which effected multiple changes to the federal securities laws to promote efficiency and capital formation by eliminating overlapping federal and state securities regulations.
With respect to mutual funds, NSMIA resolved the problem of overlapping regulation by preempting state substantive regulation and registration requirements of mutual funds, thereby providing for exclusive federal jurisdiction over the contents of a mutual fund’s prospectus and operation of each fund. NSMIA was welcomed by the mutual fund industry because it eliminated the “crazy quilt” of regulation that had made registration of mutual fund shares unnecessarily cumbersome—in some cases leading mutual funds to restrict their fund offerings to residents of certain states.
However, in order to secure the acquiescence of the states and secure NSMIA’s enactment, NSMIA preserved state authority to require mutual funds to file sales reports and to pay state filing fees based on those sales in connection with the sales reports. A handful of states have taken unfair advantage of this fee loophole.