Does Social Capital Accelerate Firms’ Adjustment Speeds Towards Optimal Tax Levels?

Abstract

We investigate whether the level of social capital in the region where a firm’s headquarters are located affects the firm’s responsiveness of altering tax strategies to achieve the optimal level of tax burden over time. As a critical cultural factor, social capital, captured as altruistic civic norms and close social networks, motivates norm-complying behaviors and inhibits norm- deviant behaviors. We expect that social capital reduces frictions associated with timely identification of an optimal tax level and prompt tax-planning adjustments to approach the optimum in a dynamic setting. Consistent with this notion, we find that firms located in areas of high social capital exhibit faster adjustment speeds towards target tax levels than those located in areas of low social capital. Moreover, social capital has an incremental effect beyond firm-specific attributes in determining adjustment speeds. In the time series, we find that the favourable effect of social capital is more pronounced during a financial crisis. Our findings are informative to tax authorities and corporate stakeholders in evaluating the impacts of the external social environment on the responsiveness of corporate tax decisions and thus the overall effectiveness of tax planning.

Keywords: Tax avoidance, Social capital, Tax-planning adjustment, Cultural influence

JEL Classification: H21, H26, M14