The Real Effects of Tax Avoidance

We analyze the implications of tax avoidance for corporate policies. First, to guide the empirical analysis, we develop a simple financing and investment model with financial constraints. In the model, the firm’s internal funds are not sufficient to finance all positive NPV projects. Depending on the firm’s capacity for external finance, engaging in tax avoidance could help improve cash flow. Such activities, however, may obscure the true financial performance and complicate the organizational structure of the firm, consequently worsening the borrowing condition. We test the empirical predictions of the model, using a panel of U.S. firms and exploit the introduction of the so-called “Check-the-Box regulations” (CTB) as an exogenous shock to the cost of tax avoidance. Results indicate that corporate tax avoidance matters for firms’ financing and has real implications on the firm level in terms of investment.”