Tax avoidance and labor investments

Abstract
I examine the relation between tax avoidance and firms’ labor investments. Consistent with risks and uncertainties from tax avoidance making firms more cautious when investing, I provide evidence that firms with low cash effective tax rates, my proxy for tax avoidance, undertake sub-optimal labor investments relative to the level justified by their underlying economic fundamentals and industry medians. I find this effect using a quasi-natural experiment around Ireland’s statutory corporate tax cut of December 1997. More importantly, I find my result to be more pronounced in sub-samples of firms exposed to greater tax risks and uncertainties, which is consistent with the view of firms withholding their investments in human capital in response to potential reductions in cash flows and shareholders’ wealth.

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Invited by Accounting, Auditing and Law