Financial Constraints and the Incentive for Tax Planning

Posted: 14 Feb 2013

See all articles by Alexander Edwards

Alexander Edwards

University of Toronto - Rotman School of Management

Casey M. Schwab

Indiana University - Kelley School of Business - Department of Accounting

Terry J. Shevlin

University of California-Irvine

Multiple version iconThere are 2 versions of this paper

Date Written: February 11, 2013

Abstract

In this study, we investigate the association between financial constraints, at both the macroeconomic and firm-specific level, and one potentially significant source of internal funds available to firms – cash savings generated through tax planning. In equilibrium a firm will undertake tax avoidance strategies if the marginal benefit (i.e., reduction in taxes payable) exceeds the marginal costs. Assuming the cost of implementing tax avoidance strategies does not increase for financially constrained firms, this suggests that firms will increase tax avoidance as access to external funds becomes more costly. Measuring financial constraints based on both macroeconomic measures (change in GDP and bank lending tightening) and firm-specific measures (a financial distress indicator based on the Altman Z-score and the decile ranking of the Whited and Wu 2006 financial constraint index), we find that firms facing financial constraints exhibit lower cash effective tax rates. Understanding how financial constraints affect tax avoidance and the interplay between macroeconomic forces and firm-level tax avoidance behavior is important as legislators look for ways to reduce the federal deficit.

Keywords: tax planning, cash taxes, financial constraints, government revenues

JEL Classification: E69, H25, H60

Suggested Citation

Edwards, Alexander S. and Schwab, Casey M. and Shevlin, Terry J., Financial Constraints and the Incentive for Tax Planning (February 11, 2013). 2013 American Taxation Association Midyear Meeting: New Faculty/ Doctoral Student Session. Available at SSRN: https://ssrn.com/abstract=2216875

Alexander S. Edwards

University of Toronto - Rotman School of Management ( email )

105 St. George Street
Toronto, Ontario M5S 3E6 M5S1S4
Canada

Casey M. Schwab (Contact Author)

Indiana University - Kelley School of Business - Department of Accounting ( email )

1309 E. 10th Street
Bloomington, IN 47405
United States

Terry J. Shevlin

University of California-Irvine ( email )

Irvine, CA California 92697-3125
United States
2065509891 (Phone)

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