Corporate tax behavior and political uncertainty: Evidence from national elections around the world

Abstract

AbstractWe construct a sample of firms in 36 countries with 158 elections to examine corporate tax behavior in the face of political uncertainty. We define political uncertainty as unmeasurable unpredictability regarding governmental policies or regulatory shifts, such as tax rates, tax enforcement and general economic conditions, emanating from a possible change in political leadership. If insufficient information exists to develop plausible expectations about future tax‐related outcomes, ambiguity‐averse managers will attend to relatively more pessimistic priors and assume the worst‐case scenario. We expect firms to increase tax avoidance in election years given uncertainty regarding the post‐election tax and macroeconomic environment. Our results are consistent with this argument. Firms increase their corporate tax avoidance in election years, consistent with managers exercising current tax planning strategies while it is still most optimal to do so given post‐election uncertainty. The effect is increasing in the political uncertainty associated with the election. Specifically, for elections that are closely contested, representing uncertainty regarding the victor, or held in countries with fewer electoral checks and balances, representing uncertainty regarding the ease of effectuating potential post‐election changes. We document increased reshuffling of tax burdens across firms after elections, further supporting that elections reflect periods of heightened tax uncertainty.