Abstract This paper investigates how tax loss carryforward (LCF) rules influence corporate bankruptcies and market-wide productivity. Analyzing data from 29 European countries, I find that stricter LCF deductibility limits significantly increase bankruptcy likelihoods. This is because stricter LCF deductibility limits lower the present value of net operating losses (NOLs) as tax assets, reducing the incentive to keep struggling firms alive. This effect is especially pronounced for business group firms, which can support struggling affiliates through internal capital markets to strategically exploit NOLs. My results suggest that lenient LCF deductibility limits can sustain unproductive firms, impacting market-wide resource allocation and productivity. These findings highlight the trade-off in tax policy between supporting firm survival and ensuring efficient resource allocation.

Taxation is a central economic policy tool, with governments increasingly using tax policy to stimulate local economic growth and also regulate multinational firms. We review the empirical literature that studies the effect of tax policies on firms’ investment, employment, and other real outcomes. Building on the neoclassical theory of corporate taxes and tangible investment, we propose an organizing framework for our review that captures the wide set of tax policies and firm responses examined in accounting research. This framework highlights four dimensions along which accounting scholars contribute to the literature: (i) documenting the role of financial reporting incentives as a moderating factor in firms’ real responses, (ii) studying firms’ reporting versus real responses, (iii) quantifying real effects of tax disclosure regulations, and (iv) improving measurement of firms’ tax status and proxies for investment and employment. We identify open questions for future research and suggest new international, federal, and local settings that may help uncover underlying mechanisms driving observed economic phenomena. Specifically, we encourage scholars to further distinguish firms’ reported and real responses to tax changes and improve measurement of these outcomes, especially in settings related to environmental taxation or settings in which tax avoidance and real outcomes are closely linked.