Political Connections, Financial Constraints, and Corporate Taxation
70 Pages Posted: 17 Aug 2021 Last revised: 29 Apr 2022
Date Written: March 1, 2021
Prior literature shows that politically connected firms engage in greater tax planning. We argue that this relation is moderated when firms are financially constrained. Specifically, we hypothesize that political connections help constrained firms access external financing and consequently reduce these firms’ incentives to use tax planning, ie., tax savings, as a source of internal financing. We find that after a plausibly exogenous increase in political connections arising from close congressional elections, although financially unconstrained firms increase their tax planning, constrained firms decrease it. Constrained firms are also more likely to obtain new bank loans and issue new public bonds, and the costs of debt are significantly lower after increases in political connections. We further show that decreases in tax planning are more pronounced for constrained firms that obtain new bank loans and issue public bonds, and when the connected politicians serve on the banking-related committees. Collectively, our paper highlights the importance of financial constraints in understanding the tax planning of politically connected firms.
Keywords: Political connections, corporate tax planning, financial constraints, external financing
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