Information Sharing between Tax and Statutory Auditors: Implications for Tax Audit Efficiency

Abstract

ABSTRACT We examine whether tax audits become more efficient if tax auditors have access to information about statutory audit adjustments. To this end, we extend the standard tax compliance game by including a statutory auditor and analyze the strategic interactions among a firm issuing financial and tax reports, a statutory auditor, and a tax auditor. We show that granting the tax auditor access to information on statutory audit adjustments can, in some cases, increase tax revenues while simultaneously decreasing tax audit frequency. Thus, more information sharing between statutory and tax auditors could be a policy instrument to combat tax evasion and increase tax audit efficiency. However, the tax audit efficiency enhancing effect comes at the cost of a reduction in financial statement quality as the probability of overstated financial assets increases. Moreover, depending on the importance of firms' financial statement valuation, the additional information may also reduce tax revenues. The regulator must, therefore, carefully weigh the potential efficiency gains from information sharing on statutory audit adjustments that are derived in this study against the potential efficiency losses.