Strategic Cost Shifting and State Tax Minimization

Abstract

In this study, we predict and find that multistate bank holding companies strategically allocate costs among subsidiaries to minimize tax. In particular, we find that high tax subsidiaries report higher costs than low tax subsidiaries within the same bank holding company. Additional tests provide evidence of cost shifting rather than operational differences amongst states. We find that high tax subsidiaries of multistate bank holding companies report higher costs than single state banks in the same high tax state, and that our results are concentrated among cost categories that are easier to shift. Additionally, we document that banks use cost allocation as an alternative to strategic recognition of securities gains to minimize taxes. Our study provides a unique contribution to the cost allocation and tax management literature by directly linking tax reduction incentives to cost allocation and documenting an alternative type of state tax minimization strategy in the banking industry.