Theft and Taxes

This paper analyzes the interaction between corporate taxes and corporate governance. We show that the characteristics of a taxation system affect the extraction of private benefits by company insiders. A higher tax rate increases the amount of income insiders divert and thus worsens governance outcomes. In contrast, stronger tax enforcement reduces diversion and, in so doing, can raise the stock market value of a company in spite of the increase in the tax burden. We also show that the corporate governance system affects the level of tax revenues and the sensitivity of tax revenues to tax changes. When the corporate governance system is ineffective (i.e., when it is easy to divert income), an increase in the tax rate can reduce tax revenues. We test this prediction in a panel of countries. Consistent with the model, we find that corporate tax rate increases have smaller (in fact, negative) effects on revenues when corporate governance is weaker. Finally, this approach provides a novel justification for the existence of a separate corporate tax based on profits. * A previous version of this paper circulated under the title Corporate Governance and Taxation. We thank Mehmet Beceren, Kent McNellie, Bill Simpson, and James Zeitler for their valuable research assistance. We also thank Milton Harris (who suggested the title), Joel Slemrod, Per Stromberg, René Stulz, and participants at seminars at the University of Chicago, the University of North Carolina at Chapel Hill, the University of Michigan, the Kennedy School of Government, Harvard Business School, the NBER University Research Conference, the NBER Public Economics Summer Institute, Vanderbilt University, the Wharton School and Moscow’s NES for their comments. Desai and Dyck thank the Division of Research at Harvard Business School and Zingales the Center for Research on Security Prices and the George Stigler Center at the University of Chicago for financial support.