Avoiding Taxes to Fix the Tax Code

Abstract

Most corporate tax codes constrain capital investment because the cost of capital investment is usually not fully deductible from taxable income. We examine whether firms avoid taxes to loosen such tax code constraints on their investment. Exploiting increases in capital investment incentives from stricter employment protection, we find that firms avoid more taxes and their capital investment response increases with tax avoidance opportunities, both especially when the deductibility of capital investment costs is limited. These findings suggest that tax avoidance mitigates the distortions from tax code constraints on investment.

Keywords: Tax distortions, tax avoidance, employment protection, labor regulation

JEL Classification: G32, H26, J63, K31, M41