Corporate “Flooding”: A New Theory of Corporate Tax Avoidance in an Era of Common Ownership
42 Pages Posted: 30 Dec 2019 Last revised: 11 Sep 2021
Date Written: December 31, 2019
The increase in the overlapping institutional ownership of public corporations, known as common ownership, has coincided with a surge in corporate tax avoidance. Under the domination of large, diversified institutional shareholders, public companies are inundating the tax agency with controversial tax returns, avoiding taxes on billions of dollars in corporate income. Coupled with the agency’s limited audit capacity, this simultaneous surge in levels of corporate tax avoidance reduces the probability that noncompliant behavior will be detected and penalized. As a result of this corporate behavior—which this Article terms “flooding”—tax avoidance becomes less risky, changing the way public firms approach legal risks and creating an escalating cycle of tax avoidance. This undesirable outcome is counter to the classic deterrence theory model, which assumes that the threat of enforcement deters noncompliance.
This Article identifies the role that common institutional owners play in facilitating the flooding phenomenon and pinpoints causal links between common ownership and tax noncompliance. By revealing the tax avoidance consequences and enforcement challenges that follow in the wake of common ownership, this Article demonstrates how institutional investors distort the compliance incentives of public corporations. This distortion leads to a reduction in tax revenues at a time when policymakers are trying to reduce budget deficits, and exacerbates the inequality among taxpayers. To address these issues, this Article proposes a double sanctions regime whereby institutional investors would be penalized along with their portfolio companies for illegitimate tax avoidance behavior. Such a regime could help restore deterrence and thus alleviate one detrimental effect of common ownership that has been overlooked.
Keywords: Common ownership; Institutional investors; Corporate governance; Corporate tax avoidance; Compliance
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