This paper investigates the effect tax havens and other foreign jurisdictions have on the income tax rates of multinational firms based in the United States. We develop a new regression methodology using financial accounting data to estimate the average worldwide, federal, and foreign tax rates on worldwide, federal, and foreign pretax book income for a large sample of U.S. firms with and without tax haven operations. We find that on average U.S. firms that disclosed material operations in at least one tax haven country have a worldwide tax burden on worldwide income that is approximately 1.5 percentage points lower than firms without operations in at least one tax haven country. Our results also show that U.S. firms face a 4.4% current federal tax rate on foreign income whether or not they have tax haven operations. Finally, we find that U.S. firms with operations in some tax haven countries have higher federal tax rates on foreign income than other firms. This result suggests that in some cases, tax haven operations may increase U.S. tax collections at the expense of foreign country tax collections.

We examine whether Delaware is a domestic tax haven. We find that taxes play an economically important role in determining whether U.S. firms locate subsidiaries in Delaware and that a Delaware-based state tax avoidance strategy lowers state effective tax rates by between 0.7 and 1.1 percentage points, on average. The tax savings represent a 15–24% decrease in the state income tax burden and translate to an increase in net income of 1.04–1.47%. However, we find that the tax benefits of Delaware tax strategies are diminishing over time in response to initiatives by state governments to limit multistate tax avoidance.

We examine the global equity supply chains of U.S. multinationals to explore how tax and nontax country characteristics affect whether firms use foreign holding companies and where they locate them. We find that U.S. multinationals supply equity from headquarters to their foreign operating companies through foreign holding companies located in countries that lightly tax equity distributions. We also find that foreign holding companies tend to be located in countries with less corruption and investment risk than the countries in which the operating companies they own are located. In addition, we provide empirical evidence that the Netherlands, a well-known location for international tax planning, is a particularly popular site for foreign equity holding companies. Our findings contribute to a nascent literature that examines ownership chains in multinational companies and a larger literature on subsidiary location decisions for multinationals. The findings also provide empirical evidence that could be useful to governments in developed countries as they attempt to reform international tax policy.

Academic research investigating the economic consequences of tax avoidance is almost always interested in the consequences of intentional, deliberate actions undertaken to reduce taxes relative to income. Therefore, it is crucial that such research distinguishes between intentional and incidental tax avoidance, since failure to do so can create endogeneity concerns and lead to incomplete and incorrect economic inferences. In this paper, we first develop a framework that conceptually defines and distinguishes between intentional and incidental tax avoidance. We highlight that the endogeneity problem arises because intentional tax avoidance is not directly observable. We consider two approaches to mitigating endogeneity concerns and apply these approaches by reexamining two influential studies that investigate the economic consequences of tax avoidance. We show how controlling for past accounting losses eliminates the effect of tax avoidance on credit spreads (Hasan et al. 2014, Journal of Financial Economics, 113 (1), 109–130) and how using an instrumental variables approach changes the sign of the relation between tax sheltering and stock price crash risk (Kim et al., 2011, Journal of Financial Economics, 100 (3), 639–662). Overall, our paper punctuates the importance of both (1) conceptually distinguishing between incidental and intentional tax avoidance and (2) econometrically addressing the challenges that arise when empirical differentiation between incidental and intentional tax avoidance is important to the research question.