Quantifying the Costs of Intertemporal Taxable Income Shifting: Theory and Evidence from the Property-Casualty Insurance Industry

Abstract

This paper presents a model of optimal tax-motivated intertemporal income shifting given a quadratic cost function that relates the costs associated with shifting income to the amount of income shifted. By formally modeling the income shifting decision, we: (1) show how parameter estimates of the income-shifting cost function can be extracted from a linear regression where a proxy for income shifted is the dependent variable, (2) provide insight about prior tax-motivated income shifting research, and (3) clarify the interpretation of independent variables that capture the interaction between tax incentives and non-tax costs. We then provide an empirical application of our method for quantifying the costs to shift federal taxable income by investigating the income shifting behavior of firms in the property and casualty (P&C) insurance industry following the Tax Reform Act of 1986. Our results suggest that the parameters of the cost function are negatively related to firm size, the cost to shift a significant amount of income are nontrivial, and the marginal cost to shift income increase as more income is shifted.