A Theory of the Tax Avoidance (Tax Planning) Continuum

Abstract

There is no precise definition to date of either tax aggressiveness or tax risk (Blouin, 2014). Accordingly, I model tax avoidance (tax planning) activity as corresponding to a gray-area continuum with endpoints representing transactions with certain tax treatments. As a modeling innovation – in contrast to tax evasion models which focus on the underreporting of ex post cash flow realizations – I assume that the taxpayer ex ante structures (plans) a transaction, and the tax authority does not contest the tax savings requested by the taxpayer, but must choose instead whether to expend resources challenging whether the transaction qualifies for favorable treatment under a vague tax law. The results enable me to distinguish between tax aggressiveness and tax risk – thereby providing an explanation for the undersheltering puzzle. The results also explain how a more aggressive tax authority may surprisingly lead to more aggressive taxpayers, and when FIN 48 liabilities are not meaningful.

Keywords: Tax aggressiveness, Undersheltering puzzle; FIN 48

JEL Classification: H26