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Paul L. Caron
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Friday, November 8, 2024

Weekly SSRN Tax Article Review And Roundup: Narotzki Reviews The Effect Of Government Transparency On Corporate Tax Avoidance

This week, Doron Narotzki (Akron; Google Scholar) reviews The Effect of Government Transparency on Corporate Tax Avoidance: Evidence from State Freedom of Information Laws by Dongdi (Grace) Gu (University of Texas-Dallas), Jiapeng He (Chinese University of Hong Kong), Ying Huang (University of Texas-Dallas), and Ningzhong Li (University of Texas-Dallas). 

Doron narotski

They say sunlight is the best disinfectant, and in the case of corporate tax avoidance, a little transparency can go a long way. In The Effect of Government Transparency on Corporate Tax Avoidance: Evidence from State Freedom of Information Laws, Dongdi (Grace) Gu, Jiapeng He, Ying Huang, and Ningzhong Li put this idea to the test, revealing how government openness can help diminish the somewhat murky practices of aggressive tax planning.

The paper addresses a timely question: how do changes in state Freedom of Information (FOI) laws affect corporate tax behavior? Furthermore, the paper fills a notable gap in the literature by linking government transparency directly to tax compliance. The authors utilize staggered changes in FOI laws as a natural experiment, employing a difference-in-differences (DiD) methodology.

DiD is often used to study the effects of policy changes by comparing differences in outcomes between groups before and after an intervention. It is effective because it controls for factors that stay the same over time, helping to isolate the true impact of the change. In this case, it clearly shows how increased transparency can reduce tax avoidance, making state-level changes a strong example of the benefits of government openness.

A strong point of the study is its analysis of the mechanisms driving the reduction in tax avoidance. The authors argue that improved tax morale, rather than stricter enforcement, is the key factor. This insight aligns well with theories on trust and reciprocity in tax compliance, suggesting that when firms perceive the government as more transparent and accountable, they are less inclined to engage in aggressive tax planning. This nuanced finding highlights the potential of non-coercive measures like transparency to achieve similar results as traditional enforcement strategies.

The policy implications are significant as these findings indicate that strengthening government transparency through FOI laws can effectively reduce corporate tax avoidance, offering a compelling alternative to costly audits and strict enforcement. By focusing on voluntary compliance rather than punitive measures, the paper advocates for reforms aimed at increasing public access to government information as a tool for improving corporate tax behavior.

However, the paper has some limitations. The use of effective tax rates as a proxy for tax avoidance, while common and acceptable, may not fully capture the complexity of firms' tax strategies, particularly for multinational corporations. I believe using supplementary metrics or finer data could enhance the authors’ analysis. Furthermore, the scoring system for FOI laws could benefit from deeper exploration, as different provisions (e.g., penalties for noncompliance) may have varying effects on corporate behavior. A more detailed breakdown would provide clearer insights into which aspects of transparency are most effective.

Also, the assumption that FOI law changes are independent warrants closer examination. States facing budget shortfalls may implement stricter FOI laws as part of broader revenue-raising strategies, which could complicate the interpretation of the results. And though it is much easier said than done, employing additional validation tests or instruments could help solidify the paper’s conclusions. Lastly, the focus on state-level changes within the U.S. context may limit the generalizability of the findings, as different legal environments could alter the relationship between transparency and tax avoidance.

Overall, this paper makes a meaningful contribution by showing the influential role of transparency in shaping corporate tax practices. The rigorous empirical approach and clear analysis offer strong evidence that greater public access to government information can curb tax avoidance. This provides a solid foundation for future research, which could explore cross-country variations or delve into other facets of government openness, such as the disclosure of tax rulings. Overall, the paper is a valuable addition to the fields of tax compliance and public policy, offering practical insights for scholars, policymakers, and practitioners aiming to enhance corporate tax compliance dynamics.

Here’s the rest of this week’s SSRN Tax Roundup:

https://taxprof.typepad.com/taxprof_blog/2024/11/the-effect-of-government-transparency-on-corporate-tax-avoidance.html

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