Why Do Not All Firms Engage in Tax Avoidance?
FAccT Center Working Paper Nr. 19/2014
48 Pages Posted: 11 Dec 2014 Last revised: 1 Jun 2016
Date Written: May 31, 2016
Empirical evidence suggests that there is substantial cross-firm variation in the extent of tax avoidance. However, this variation is not well understood. This paper provides a theoretical background for testing, and thus explaining, cross-firm differences in tax avoidance. We develop a formal model with two agents to analyze the incentives that lead firms to engage in tax avoidance. The tax avoidance decision is a function of moral hazard, tax-planning costs, and the potential to increase earnings. If the potential to increase earnings is low, the tax-planning decision is determined by moral-hazard problems. In contrast, when this potential is high, the tax-planning decision is mainly driven by tax-planning costs, such as reputational and political costs. One implication of our model is that moral hazard can (partly) explain why some firms do not engage in tax avoidance: Severe problems of moral hazard make tax avoidance less likely. Our model can be applied to test differences in tax avoidance between different types of firms.
Keywords: moral hazard, tax avoidance, tax planning
JEL Classification: H25, M41
Suggested Citation: Suggested Citation