Labor Unemployment Risk and Tax Aggressiveness

Abstract

This paper examines whether firms exhibit less tax aggressiveness in order to mitigate workers’ exposure to unemployment risk. We use unemployment insurance (UI) benefit laws as a proxy for unemployment risk and multiple measures of tax aggressiveness. Given that tax aggressiveness is risky and costly for the firm and its employees, we argue that high state UI benefits lower labor unemployment risk and, hence provide firms with an opportunity to exhibit more tax aggressiveness. Consistent with this hypothesis, we find a negative relation between firms’ tax aggressiveness and unemployment risk. In additional analysis, we also find that the negative relation is more pronounced for firms in industries that are more labor intensive. Our results are robust to the exclusion of industries with a dispersed labor force and an alternative proxy for unemployment risk. Overall, our findings suggest that labor market frictions have implications for corporate tax policy.