Tax Avoidance and the Real Effect of Tax-Risk Disclosures

57 Pages Posted: 16 May 2019 Last revised: 25 May 2019

See all articles by Charles McClure

Charles McClure

University of Chicago Booth School of Business

Date Written: May 6, 2019

Abstract

I study the financial reporting effect of tax-risk disclosures (“FIN 48”) on tax avoidance. To isolate this effect from other factors that influence tax avoidance, I build a dynamic structural model in which a firm chooses a set of tax-saving projects in each period to maximize shareholder value. In this model, the firm trades off the tax savings with the financial-reporting costs, tax authority scrutiny, and operational frictions imposed by tax avoidance that reduce pre-tax income. I find that the FIN 48 disclosure increases effective tax rates by 2.8 percentage points relative to when firms can immediately recognize all of the tax savings on the income statement. I also find that average operational frictions from tax avoidance decrease pre-tax earnings by 7.4%. The magnitude of these frictions suggest they have a large impact on firms' tax planning and can explain the “undersheltering puzzle.”

Keywords: FIN 48, Tax Avoidance, Financial Reporting, Real Effects, Non-Tax Costs

JEL Classification: G14, H25, H26, M41, M48

Suggested Citation

McClure, Charles, Tax Avoidance and the Real Effect of Tax-Risk Disclosures (May 6, 2019). Chicago Booth Research Paper No. 19-14; Fama-Miller Working Paper. Available at SSRN: https://ssrn.com/abstract=3373777 or http://dx.doi.org/10.2139/ssrn.3373777

Charles McClure (Contact Author)

University of Chicago Booth School of Business ( email )

7737024885 (Phone)

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