A Re-examination of Firm Size and Taxes

Abstract

We document that larger firms pay substantially lower cash effective tax rates (cash ETRs) in the long-term than do smaller firms. Over a ten-year period, firms in the largest decile pay 10.8 p.p. (26 percent) lower taxes than those in the smallest decile, while this gap balloons to 14.4 p.p. (35 percent) for the largest 1 percent of firms. This pattern is robust to various specifications, but vanishes when cash ETRs are measured annually. The relation between firm size and taxes over the long run cannot be explained by foreign operations, depreciation, or R&D spending, characteristics commonly associated with aggressive tax practices. Meanwhile, the observed tax inequality is strongly associated with the incidence of losses. This indicates that smaller firms may face higher effective tax rates due to inefficient use of losses, and that larger firms are better able to smooth pretax income to avoid losses. In contrast to the two dominating theories ascribing the association between firm size and taxes to political activities, our findings suggest that the incidence and treatment of losses is first order in understanding the significant tax inequality that we document.

Keywords: Firm size, taxes

JEL Classification: H25, H26, L25