Growing “political power” of large frms and the downward cash ETR trend

Whether large firms pay less taxes than small firms is an important question for evaluating the fairness and efficiency of the tax regime. For more than 40 years, the relationship between the cash effective tax rates (ETR)1 and firm size has been explained using one of the two competing theories. The “political cost” theory assumes a positive size-ETR relationship, while the “political power” theory assumes a negative relationship.

Recent anecdotal evidence blames the largest US corporations for their close-to-zero federal tax payments, which, however, is incompatible with the conventional impression of large firms as main tax contributors. For example, in their review, Belz, von Hagen and Steffens (2019) find more evidence for the political cost theory.

It is necessary to examine if there is any change in the size-ETR relation in the recent history. Besides the policy implications of this analysis, tracing the size-ETR relation can also help understand the downward ETR trend in the last three decades. Since the tax rate overhaul in 1986, the average ETR among US corporations declined steadily. Econometrically, a growing negative relation between firm size and ETRs suggests the ETRs of large firms are declining faster relative to small firms and can drive a downward ETR trend. In this paper, we examine whether the size-ETR relation is evolving over the last three decades and test whether the evolving size-ETR relation has driven the downward ETR trend.