Use of Increased Operating Cash Flow by Firms that Avoid Taxes

Abstract

We investigate whether firms use pretax cash flow freed-up by tax avoidance to make real investments. We expect uncertainty about tax avoidance to affect how this cash is used, and predict that firms facing low (high) financial constraints will use more of this cash for real investments (savings). Using a flow-of-funds model we identify uses of pretax operating cash flow, demonstrate how these uses change as tax avoidance increases, and find results generally consistent with predictions. We separate cash flow freed-up by permanent (temporary) strategies and find firms use this cash flow for real investment (reducing external financing).