In times of uncertainty like those we are currently experiencing – post-pandemic, energy crises, inflation, tensions in the Middle East and the war in Ukraine – governments are exploring various policies to support firms in maintaining their operations. A common measure is the reduction of corporate income taxes.
These reforms aim to stimulate local investment and economic growth, as firms can reallocate resources freed by reduced tax liabilities into new investments. However, such reforms can also lead to unintended effects, such as intertemporal income shifting, where firms adjust the timing of income and expenses to optimise their tax benefits. Accordingly, tax reforms provide researchers with valuable insights into how changes in corporate tax rates influence business behaviours.
In this context, this article investigates whether private firms engage in intertemporal income shifting under corporate tax cuts and how this affects their investment levels and efficiency. We use a sample of private Spanish firms to conduct the empirical analysis, leveraging a specific tax reform Spain implemented in 2007.
Firms may engage in aggressive tax strategies if this aligns with their strategic objectives
Since intertemporal income shifting is a tax strategy that is not context-specific, we argue that our findings are applicable to other contexts, such as the US, where this behaviour has been observed in public firms.
Shifting strategies
Intertemporal income shifting occurs when firms move income from periods with higher tax rates to those with lower rates to reduce their overall tax burden, as shown in the graphic.
This practice is particularly relevant for private firms due to their unique characteristics, such as lower non-tax costs and reduced market pressure compared to public firms. This implies that private firms may be more likely to engage in aggressive tax strategies if this aligns with their strategic objectives.
It is also true that private firms may be cautious about intertemporal income shifting if it imposes additional tax costs on their contracting partners or if it disrupts their operational efficiency. However, despite these concerns, the tax benefits from lower tax rates often encourage firms to explore intertemporal income-shifting strategies to improve their financial position.
In our study, we found that private firms engaged in intertemporal income shifting strategies in response to tax-rate cuts to obtain more tax savings. In particular, we observed that firms, on average, shift income equal to 0.685% of their total assets to the period with the lower tax rate.
Investment impact
The availability of additional funds from tax savings can be particularly relevant for private firms, which often rely more on internal financing compared to their public counterparts. Thus, if firms can successfully increase their cashflows through intertemporal income-shifting strategies, they are likely to also increase their investments in the post-reform period.
Firms used the savings to increase human capital investment
Indeed, in accordance with this theoretical view, our results indicate that firms that implemented intertemporal income-shifting strategies used the tax savings to increase human capital investment but they did not increase capital expenditure investment levels.
Investment efficiency
While increased investment level is a positive outcome, it does not always guarantee efficiency. For example, firms may underinvest if they prioritise holding cash reserves over pursuing new projects, or if they fail to make strategic hiring and growth-related decisions. Conversely, firms may overinvest in underperforming projects if they are influenced by internal pressures or management incentives.
We considered whether the additional investments highlighted above were optimal or whether their strategies led to suboptimal outcomes. Indeed, efficient investment behaviours could be a sign of effective use of tax savings, while inefficient behaviours may indicate potential drawbacks of aggressive income shifting. Our findings show that the additional investments made after the implementation of intertemporal income-shifting strategies were beneficial for companies to keep the necessary labour force to support the expected business growth.
Conclusion
Overall, our study provides valuable insights into the behaviour of private firms in response to corporate tax cuts. Our results suggest that aggressive income shifters leverage tax savings to boost investment levels and achieve investment efficiency. However, this comes with the caveat of potential unintended consequences from the tax reform (ie intertemporal income shifting), highlighting the need for policymakers to consider the nuances of tax reforms in shaping effective economic strategies.
Aggressive shifters not only increase their investment levels but also manage to do so efficiently
This research makes several key contributions. First, it enhances the understanding of how private firms respond to tax reforms, specifically in the context of intertemporal income shifting. Unlike public firms, private firms are less affected by market pressures and reporting requirements, which can amplify their tax-planning activities.
Secondly, our findings suggest that aggressive shifters not only increase their investment levels but also manage to do so efficiently, contrasting with some prior research on public firms.
Finally, our evidence indicates that aggressive tax planning can lead to increased investments, but also underscores the need for targeted measures to mitigate unintended tax-planning behaviours. For example, providing tax incentives tied to specific investment outcomes could help align private firms’ strategies with broader economic goals.
