The Common Ownership Tax Strategy

Danielle A. Chaim (Bar-Ilan University; Google Scholar), The Common Ownership Tax Strategy, 101 Wash. U. L. Rev. 501 (2023):

The recent mass shift by American retail investors into index funds has given rise to a modern form of common ownership. Significant stakes in most public companies are now held by a core group of large, diversified institutional investors. In parallel, this rise in common ownership has been accompanied by unprecedented levels of corporate tax avoidance. Recent evidence suggests that under the domination of these powerful shareholders, public companies can reduce their tax liability more aggressively, shirking U.S. tax obligations worth billions of dollars.

This Article offers a novel theory that identifies the direct connection between these two trends. It argues that common ownership facilitates a strategic tax behavior that I term “corporate flooding.” In this strategic maneuver, companies with common ownership-ties opt to simultaneously increase their tax-avoidance behavior. Operating in concert creates a surge in noncompliance, flooding the tax agency with complex cases and rapidly exhausting its limited audit resources. The strategy works by simply reducing the probability of noncompliance being detected and penalized, by sabotaging the agency’s capacity to implement anti-avoidance measures. This outcome­—which runs counter to the classical deterrence theory model which assumes that the risk of enforcement increases as noncompliance levels decline—demonstrates how common ownership distorts corporate compliance incentives, changing the way public firms approach legal risks.

Given the social cost of common ownership on this scale—and the resulting systematic compliance distortion—the practice of corporate flooding requires an immediate policy response. This Article therefore proposes a double-taxation sanction regime whereby institutional investors would be penalized along with their portfolio companies for illegitimate tax avoidance. Such a regime would not only help restore the deterrent effect but may also incentivize common institutional investors to pay a closer look at the tax practices of their companies.