Wednesday, October 11, 2017
Omri Marian (UC-Irvine) presents Is All Corporate Tax Planning Good for Shareholders at Pennsylvania today as part of its Tax Policy Workshop Series hosted by Chris Sanchirico and Reed Shuldiner:
Multiple commentators argue that corporate managers have an affirmative duty to engage in corporate tax planning. Underlying this argument is the assumption that reduced corporate tax liability enhances shareholder value. In this article, I explain that this common perception is frequently incorrect. Corporate tax reduction schemes may increase the overall tax burden on shareholders. I make the following descriptive arguments in this regard:
First, I show that in many cases, successful (and legal) corporate tax planning schemes are not Pareto-optimal to shareholders. Some classes of shareholders (generally, tax-exempt shareholders) may see a net benefit, while other shareholders (usually taxable shareholders) experience a net loss. Second, I show that in certain instances it is reasonable to expect that legal corporate tax planning schemes will be overall inefficient. Meaning, the losses to taxable shareholders may exceed the gains to tax-exempt shareholders. Lastly, I show that because of an underappreciated agency problem, shareholders approve inefficient corporate tax plans, even when information about the potential detriment is freely available.
The reason is that in U.S. equity markets tax-exempt shareholders, many times, hold the majority vote. Tax-exempt shareholders (unlike taxable shareholders) always stand to benefit from corporate tax planning. Tax-exempt investors also have an incentive to allow the corporation to carry the management’s personal tax cost, in order to secure management’s support for the transaction. In summary, tax-exempt shareholders and managers rationally (and legally) collaborate to reduce corporate taxes, by shifting the tax burden to minority taxable shareholders.
There are important legal and normative implications to such outcomes: First, the fact that corporate tax planning can be detrimental to shareholders casts serious doubt on the argument that managers have a duty to engage in corporate tax planning. Second, the market dynamics I explore expose a shortcoming in U.S. corporate and securities laws, which allows (in fact, encourages) inefficient transactions to take place. Lastly, corporate tax plans that shift burden to taxable shareholders are unfair. Assuming government designed our tax system with particular distributive policies in mind, the corporate tax schemes I describe violate such policies through private actions that are not between willing parties. I explore several potential remedies to these problems, and conclude that the best course of action is to require that taxable shareholders vote as a class in all corporate transactions that result in shareholder tax liability.