Legal Environment and Corporate Tax Avoidance: Evidence from State Tax Codes

Abstract

This study examines the effect of legal environment on corporate state income tax avoidance. We find that the extent of penalties on corporate officers reduces state tax avoidance. However, we find no evidence that the extent of penalties on shareholders reduces state tax avoidance. Thus, the legal environment faced by managers has a greater deterrent effect on tax avoidance than does the legal environment faced by shareholders. Only when managerial ownership is high do we find evidence that shareholder penalties affect corporate tax avoidance behavior. Our study contributes to the literature on agency problems related to corporate tax reporting.

Keywords: Agency Costs, Legal Environment, Legal Penalties, Tax Avoidance