The Effect of Foreign Competition on Corporate Tax Avoidance

Courtesy of Nader Atawnah, Balasingham Balachandran, Huu Nhan Duong, Jeffrey Pittman, and Edward Podolski

The US Federal government deficit totaled $984 billion in 2019, representing 4.7% of GDP. Aggressive tax evasion and avoidance strategies by corporations are one contributing factor to this shortfall. By some accounts, profit shifting and tax evasion strategies reduce the IRS’s corporate revenue by as much as 14%. Similarly, the most recent IRS for tax years 2011-2013, published in 2019, shows that underreported corporate taxes account for 17% of total corporate taxes collected and 4% of the federal budget deficit over this period. Such statistics have led Nobel laurate Joseph Stiglitz to proclaim that firms’ “failure to pay [taxes] is hitting governments’ ability to fight the climate crisis and inequality.” In our paper, we examine the degree to which aggressive tax avoidance strategies are the consequence of external macroeconomic environmental factors. Specifically, we explore the role that foreign competitive pressure plays in corporate tax avoidance.


There is no academic consensus on the degree and severity to which macroeconomic factors influence firms’ tax avoidance strategies. Existing literature on the subject suggests that tax avoidance can be an effective way of boosting internal sources of liquidity that have little to no effect on firm performance. However, there are numerous reasons to believe that the macroeconomic environment plays no role in determining tax avoidance strategies.

First, many factors that influence tax avoidance, such as industry membership, location decisions, investment in research and development activities, or intangibles, are the result of long-term strategic planning that might be difficult and costly to change in response to volatile external factors such as foreign competition. Second, firms facing greater foreign competitive threats tend to have weaker financial disclosure practices, which can increase the probability of an IRS audit. The probability of IRS audits has been shown to deter aggressive tax planning strategies. Third, the existing literature already identifies a comprehensive set of factors that explain the cross-sectional variation in firms’ tax management strategies. These include managerial characteristics and incentives, ownership structures, and external stakeholder oversight, among others. Accordingly, it is plausible that firms already minimize their tax burden, and that time-varying changes in the competitive environment have no further perceptible impact on corporate tax avoidance activities.

In light of these conflicting predictions, there remains an empirical question about the ultimate effect of the foreign competitive environment on corporate tax planning activities.


In analyzing a large sample of U.S public manufacturing firms from 1993 to 2012, we find that firms in industries that are exposed to greater levels of foreign competition engage in tax avoidance strategies to a greater degree, including the most aggressive forms of tax avoidance such as tax sheltering. In fact, our results suggest that in comparison to other commonly used predictors of tax avoidance in the accounting literature exposure to foreign competition is one of the most significant determinants of tax avoidance strategies. Our results are based on a number of alternate empirical methodologies and robustness tests, including simple regression analysis with fixed effects, two-stage least squared analysis, and quasi-natural experiments where we employ plausibly exogenous shocks to the competitive environment, represented by the granting of permanent normal trade relations status to China in 2001 and the large appreciation of the US dollar between 1995 and 2002.

Additionally, we find that the competitive environment does not affect all firms uniformly. In particular, cross-sectional analysis implies that the association between foreign competition and tax avoidance is most pronounced among firms that: (i) are financially constrained; (ii) have the greatest ability to implement tax avoidance policies; (iii) have strongly aligned incentives between managers and shareholders; (iv) appoint high-quality auditors; and (v) attract more analyst coverage.

In our final set of analyses, we explore the economic implications of foreign competition induced tax avoidance on firm performance and CEO career outcomes. First, we evaluate whether firms that adopt aggressive tax avoidance strategies as a way of dealing with increased import competition exhibit any discernable benefits. We find that tax-avoidant firms exposed to high levels of foreign competition experience substantially better performance and make substantially higher levels of investment compared to their matched non-tax-avoidant counterparts. In contrast, among firms exposed to low levels of foreign competition, there is no apparent difference in performance or investment between the tax-avoidant and non-tax avoidant firms. These results suggest that the external competitive environment greatly influences the efficient use of cash flows freed-up by tax avoidance.

Second, since tax avoidance strategies are not mechanical and require a high degree of skill from top executives, a natural empirical implication stemming from our analysis is that CEOs who excel at minimizing tax liabilities when subject to increased foreign competitive threats enjoy superior career outcomes. We test this conjecture by constructing a measure which captures the sensitivity between import competition and tax avoidance for each manager over their entire career, and relating this sensitivity measure with career outcomes (such as tenure length and average total pay) in a pure cross-sectional regression. We find that CEOs who respond to foreign competition with more aggressive tax policies tend to have longer tenures and higher total pay. This result reveals that equity and labor markets reward CEOs who adopt aggressive tax policies to combat foreign competition.


Our analysis offers fresh insights into the interplay between foreign competition and corporate ethics. In an influential paper, Andrei Shleifer argues that competition encourages the spread of a wide range of unethical behaviors, such as employment of child labor, corruption, and earnings manipulation. Our paper shows that foreign competition induces firms to adopt aggressive tax positions, which can be viewed as unethical and counterproductive to societal welfare. Nevertheless, the entirety of our results caution against overly simplistic views of corporate ethics, since our study implies that tax avoidance strategies are an economically justified strategy for firms facing greater constraints stemming from foreign competition. We suggest that policymakers take a more holistic perspective when setting trade policies in order to account for the inevitable responses that firms must make in a more constrained environment.

Our results may also inform the public policy discourse concerning tax avoidance. For example, the Organization for Economic Co-operation and Development is implementing the OECD/G20 Base Erosion and Profit Shifting Project which is explicitly aims to reduce the costs of tax avoidance to governments around the world. Unless policymakers have a deeper understanding of the externalities associated with stringent tax enforcement rules in an increasingly globalized and liberalized environment, they run the risk of unintentionally motivating firms to pursue strategies that may have even more detrimental societal consequences than tax avoidance. For example, firms could substantially reduce investment, lay off workers, or shirk their corporate social responsibilities.

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