The Indirect Effect of Import Competition on Corporate Tax Avoidance

Abstract

The role played by competition in corporate tax avoidance is theoretically unclear in the existing literature. This paper empirically examines this, with a focus on import competition. I exploit financial statements to measure tax avoidance of US-listed firms and the conferral of the Permanent Normal Trade Relations status on China as a quasi-natural experiment to establish causality. The results reveal a positive effect of import competition on corporate tax avoidance. Furthermore, they are entirely driven by multinational enterprises. In response to the China shock, these firms invested in intangible assets to escape competition and these intangibles also allowed them to shift more profits towards low-tax countries. These findings shed light on the determinants of corporate tax avoidance. More generally, they help understand the decline in the average effective tax rate of US publicly listed firms and the recent backlash against large corporations and globalization.

Keywords: Corporate tax avoidance, import competition, multinational firms, profit shifting, intangibles

JEL Classification: F14, F60, H25, H26, L60