Tax Avoidance through corporate accounting: Insights for corporate tax bases

Abstract

How do firms respond when a tax reform changes the relative costs of inputs? We exploit a reform in Texas that broadened the corporate tax base and created a 1% tax wedge favoring both cost of goods sold (COGS) and worker compensation over other types of expenses. We find no discernible real change in inputs, and little avoidance response into worker compensation, but find a large avoidance response reclassifying costs into COGS (a 4% base reduction, with elasticity -5). Our results highlight the importance of enforceable boundaries when designing broader corporate tax bases.