This paper examines whether ties to politicians by corporate boards of directors weaken the effectiveness of tax authorities in constraining tax avoidance in China. We use a unique data set to measure geographic time‐variant tax enforcement, including the probability of income tax audit, the expertise of tax officers, and the consequences of underreporting tax liabilities. Based on a sample of 11,121 firm‐years from 2003 to 2013, we find that the deterrent effect of the probability that a firm's taxable income understatement will be detected and lead to heavy penalties is significantly undermined if the board is politically connected. To enhance our analysis, we use opportunities for income shifting, the most likely mechanism through which Chinese firms avoid taxes on an ongoing basis, to illustrate how connected boards exert power to unwind the constraining effect of tax enforcement. Overall, our results suggest that a board's ties to politicians can be a significant challenge to the effective enforcement of tax compliance in a politically controlled economy.

The effects of tax rate changes on corporate profitability are not fully understood. Implicit tax theory predicts a positive relation between country-level tax rates and firm-level pretax returns. Conversely, income shifting should make reported pretax returns inversely related to tax rates. Among single-country European firms, we find robust evidence of corporate implicit taxes following tax rate changes, concentrated in firms that rely less on intangible assets and firms in closed economies (non-EU countries). Among multinational firm affiliates, we find the effects of income shifting outweigh the effects of implicit taxes for firms with high intangibles and in countries with open borders. Our results imply income shifting estimated using only reported profits is less biased by implicit taxes in settings with open economies and firms with unique inputs or products. Our evidence also helps explain prior evidence of decreasing corporate implicit tax effects over time, particularly for multinationals.

We develop a model to examine the effects of Financial Accounting Standards Board (FASB) Interpretation No. 48, Accounting for Uncertainty in Income Taxes (FIN 48), on the strategic interaction between publicly traded corporate taxpayers and the government. Several of our findings contradict conjectures voiced by members of the business community regarding the economic effects of implementing FIN 48. Specifically, taxpayers with strong facts obtain higher expected payoffs from uncertain tax benefits and some disclosed liabilities understate the expected tax liability. Consistent with the common conjectures, however, some taxpayers are more likely to be audited or are deterred from entering into transactions that generate uncertain tax benefits because of FIN 48.

We investigate whether geographic proximity between corporate headquarters and IRS regional offices affects corporate tax avoidance and the likelihood and productivity of IRS examinations. Using geographic distance to represent information asymmetry, we find that corporations avoid more tax when located closer to the IRS unless they are close to an IRS industry specialist. This finding is consistent with taxpayers believing proximity provides them with an information advantage over the IRS. From the perspective of the IRS, we find that the Service is more likely to audit nearby companies and to assess more tax per hour from nearby taxpayers, except during constrained budget years. IRS audit likelihood and productivity are unaffected by the presence of nearby industry specialists, consistent with industry specialist proximity already constraining avoidance. Our tax compliance setting provides dual-party evidence on the proximity-information asymmetry hypothesis.

We provide new evidence about how analysts incorporate and improve on management ETR forecasts. Quarterly ETR reporting under the integral method provides mandatory point-estimate forecasts by management, but firms must record certain “discrete” tax items fully in the quarter in which they occur, polluting these forecasts. We investigate management ETR accuracy, analysts' decisions to mimic management's estimate, analysts' accuracy relative to each other or to management, and dispersion. Our comprehensive analysis reveals that analysts deviate from management more and are more accurate relative to management as complexity increases, with real effects on EPS accuracy and dispersion. In contrast to prior research that analysts ignore or are confused by taxes, we provide evidence that analysts pay attention to taxes and improve on management estimates. Based on our evidence that management's quarterly ETRs have less predictive value in the presence of discrete items, we suggest standard-setters reexamine the discrete item exception to require more disclosure.

FIN No. 48, Accounting for Uncertainty in Income Taxes (FASB 2006), requires firms to disclose tax reserves and to record changes in tax reserves at adoption of FIN No. 48 as cumulative effect adjustments in stockholders’ equity. We predict that between the enactment and adoption of FIN No. 48, relative to historical levels, firms settle disputes more often to potentially decrease visibility to the IRS and release reserves more often to reduce scrutiny and increase earnings (as opposed to retained earnings). We analyze 2005 and 2006 10-Qs and 10-Ks for the 100 largest nonfinancial, nonutility firms followed by analysts. Between enactment and adoption of FIN No. 48, relative to historical levels, firms report more settlements with tax authorities and release reserves more frequently. In addition, firms with higher IRS deficiencies are more likely to settle disputes. Between enactment and adoption of FIN No. 48, firms increased earnings by releasing $4.4 billion of tax reserves, nearly equaling the $4.5 billion released at adoption.