Corporate Tax Enforcement and Business Activity

Abstract

We examine the consequences of corporate tax enforcement for business activity. Employing two different empirical approaches—a regional design and a firm-level design—we document that corporate tax enforcement is negatively associated with business activity. This association is economically significant and is robust to tests that mitigate concerns regarding endogeneity and measurement. Furthermore, we find that the negative association between tax enforcement and business activity varies substantially in the cross-section: it is stronger for regions and firms for which access to external financing sources is more restricted, for which compliance costs are likely higher, and for which the ex-ante costs of tax enforcement are greater. Furthermore, we find that tax enforcement aimed at one firm can affect the business activity of connected firms. Our findings suggest that the effects of tax enforcement on business activity are economically important and heterogeneous, which should be of interest to academics and policymakers.

Keywords: corporate tax enforcement, business activity, local economies, employment

JEL Classification: H25, H26, R11, R12