Financial Constraints and Cash Tax Savings

TLDR

The study investigates how financial constraints affect firms’ cash tax savings through tax planning, hypothesizing that tighter constraints drive increased internally generated funds via tax planning. Financial constraints are measured using changes in firm‑specific and macroeconomic indicators, and the authors predict that higher constraints lead to greater tax‑planning activity. Firms experiencing rising financial constraints increase cash tax planning, with the largest constraint increases among profitable firms linked to 3.00–5.14 % declines in effective tax rates—equivalent to 2.87–4.82 % of operating cash flows—especially for firms with low cash reserves, and constrained firms largely achieve savings through deferral‑based strategies despite no financial‑statement benefit. JEL classifications: E69, H25, H60; data are publicly available.

Abstract

ABSTRACT We investigate the association between financial constraints and cash savings generated through tax planning. We predict that an increase in financial constraints leads firms to increase internally generated funds via tax planning. We measure financial constraints based on changes in firm-specific and macroeconomic measures. We find that firms facing increases in financial constraints exhibit increases in cash tax planning. Our results indicate that among profitable firms, firm-years with the largest increases in firm-specific constraints are associated with declines in firms' cash effective tax rates ranging from 3.00 to 5.14 percent, which equate to between 2.87 and 4.82 percent of operating cash flows. We also find that (1) the impact of financial constraints on tax planning is greatest among firms with low cash reserves, and (2) constrained firms achieve a substantial portion of their current tax savings via deferral-based tax planning strategies, despite the lack of a financial statement benefit. JEL Classifications: E69; H25; H60. Data Availability: Data used in this study are available from public sources identified in the paper.