A Re-Examination of Firm Size and Taxes

We document that larger firms pay substantially lower cash effective tax rates (cash effective tax rates (ETRs)) over the long run than smaller firms. Over a 10-year period, firms in the largest decile pay 10.4 percentage points (p.p.) (25%) lower cash taxes than those in the smallest decile, and this gap balloons to 14.4 p.p. (35%) for the largest 1% of firms. This pattern is robust to various specifications but vanishes when cash ETRs are measured annually. The relation between firm size and taxes over the long run cannot be explained by foreign operations, depreciation, research and development spending, or stock compensation, characteristics commonly associated with aggressive tax practices. Meanwhile, the observed tax inequality is strongly associated with the incidence of losses. Because smaller firms are more likely to incur significant losses, which are often not deductible against profits, they consequently face higher effective tax rates. A key finding of our paper is that the size effect reflects differences in loss rates, and consequently utilization, rather than political costs or benefits. A cross-country analysis supports these findings.

This paper was accepted by Ranjani Krishnan, accounting.

Supplemental Material: The data files are available at https://doi.org/10.1287/mnsc.2024.05865.