The Effect of Innovation on Corporate Tax Avoidance

Abstract

A large body of literature examines the determinants of corporate tax avoidance. In this paper I examine a new determinant of tax avoidance: innovation. Firms with more innovation generate more patents. Due to information asymmetry between the managers of the firm and tax authorities, firms have considerable discretion in choosing which country the patent revenue is generated in. In this study, I predict that firms with more patents will choose to attribute the revenue from those patents to countries with low tax rates. Using a relatively new data source which contains data on patents, I find evidence consistent with my predictions. Specifically, I find that patent activity is negatively associated with firms’ tax rates. The results are robust to different measures of effective tax rates and to propensity-score matching.