Explaining Corporate Tax Avoidance

Abstract

The tax avoidance literature identifies dozens of variables that are related to corporate tax avoidance, but it lacks a framework for understanding the relative importance of these variables and the theories that drive these relations. We distill thirty years of tax avoidance research into key theories, and then use novel empirical techniques to quantify the relative and total importance of proposed explanations. We find that factors tied to investment opportunities contribute more to explained variation than other proposed theories. On the other hand, agency costs and financial reporting concerns explain very little variation in tax avoidance proxies, while operating metrics that reflect firms’ underlying operations contribute more to explained variation than do many proposed theories. Further, we find that proposed theories provide very little total explanatory power for tax avoidance proxies. Finally, we find that time-invariant effects, namely manager, firm, and business unit, explain the greatest variation in tax avoidance—and that manager and business unit effects have become considerably more important over time. We offer several actionable opportunities for future research and offer several key takeaways for researchers and policymakers.

Keywords: Tax avoidance, unrecognized tax benefits, investment opportunities, financial constraints, agency costs, financial reporting, enforcement, fixed effects

JEL Classification: H25, H26, M41