Fiscal consequences of corporate tax avoidance

Multinational corporations (MNCs) shift a large share of their profits to tax havens and, due to this corporate tax avoidance, governments lose a portion of their tax revenue. In this paper, we study the consequences of multinational tax avoidance on the local governments’ tax revenues. We use financial firm-level data on the location and profits of firms operating in Germany combined with German municipal data to analyze how changes in municipal local business tax (LBT) rates affect MNC profits and LBT revenues in affected municipalities. Following an increase in the LBT rate, we find that firms that belong to more aggressive MNCs reduce profits and tax liability reported in affected municipalities. Consequently, municipalities with high exposure to aggressive multinationals experience a significant decline in LBT revenues relative to less exposed municipalities, which in some cases also affects their overall tax revenues. We then investigate potential explanations. 1 1 We thank Zareh Asatryan, Thomas Brosy, Ron Davies, Iftekhar Hasan, Katrine Jakobsen, Wojciech Kopczuk, Andreas Peichel, the seminar audience at the University of Michigan, and participants of the ZEW Public Finance Conference, the UNU-WIDER GRD Workshop, the Young Economists’ Seminar & the Dubrovnik Economic Conference, the Annual Congress of IIPF, the EEA-ESEM Congress, the Mannheim Taxation Conference, Oxford Doctoral Conference, the World Bank Tax Conference on Global Tax Equity, Zurich Conference, and Southern Economic Association for their helpful comments. We thank František Kosař for excellent research assistance. This research is supported by the UNU-WIDER’s Domestic Revenue Mobilization program and Economics Cooperation Program at Charles University. Petr Janský acknowledges support from the Czech Science Foundation (MINITAX, 25-15237X). Evgeniya Dubinina acknowledges support from the Czech Science Foundation (CORPTAX, 21-05547M), the Horizon Europe project ‘DemoTrans’ (grant 101059288) and the Charles University Grant Agency (grant 130122). • Subsidiaries of aggressive MNCs respond more significantly to local business tax rate increases. • What are the consequences of exposure to aggressive MNCs on municipal revenues? • After an LBT rate increase, LBT revenues decline in municipalities that are more exposed. • Fiscal equalization and political economy factors explain the LBT rate increases.