Is All Corporate Tax Planning Good for Shareholders?

Abstract

Does corporate tax planning benefit shareholders? The prevalent assumption is that it does, because lower corporate tax burden translates to enhanced shareholder value. In this article, I explain why this common perception is sometimes incorrect in practice. In many cases, successful (and legal) corporate tax planning schemes are not Pareto-optimal: some shareholders may see a net benefit, while others experience a net loss. Moreover, in certain instances it is reasonable to expect that legal corporate tax planning will be Kaldor-Hicks inefficient. Meaning, the financial losses incurred by some shareholders exceed the gains to others. I identify a previously underappreciated agency problem, due to which shareholders usually approve detrimental corporate tax plans, even when information about the detriment is freely available. I also show that shareholders who benefit from corporate tax plans would, in some instances, rationally cooperate with managerial rent extraction, when such rent extraction defuses managerial opposition to the corporate tax-saving plan. The transactions I describe operate to shift the corporate tax burden from some shareholders to others, while enriching managers in the process. I discuss the legal and the normative implications of this phenomenon and explore several potential remedies.

Keywords: Corporate Taxation, Tax Avoidance, Corporate Governance, Agency Costs, Tax Exempt Investors, Gross Up, Fiduciary Duties, Economic Analysis of Law

JEL Classification: K22, K34