Political scrutiny and tax law compliance: Evidence from the American Jobs Creation Act of 2004

Author: Cao, Jian, Yunhao Chen, Roy Clemons, and Michael Kinney

Release Date: Sep 29, 2016

 MEDIA CONTACT: Jim Hellegaard
561-319-2233, jhellegaard@fau.edu

This study investigates firm compliance behavior under a special tax holiday for overseas corporate profits. The American Jobs Creation Act of 2004 created a tax holiday encouraging firms to repatriate foreign earnings and invest that capital in the United States. However, the Act did not require a direct tracing of the spending of repatriated funds; accordingly, repatriating firms could ignore the investment prescriptions of the Act, since tax regulators were provided no legally viable basis to pursue violations of the spending requirements.

We use this event to provide evidence on the effect of political scrutiny on firms’ tax law compliance in a setting where regulatory enforcement plays essentially no role. Our findings suggest that repatriating firms facing greater levels of policymaker scrutiny, relative to other repatriating firms, exhibited greater compliance with the Act by increasing relative expenditures on permitted uses (R&D investment) and restraining expenditures on nonpermitted uses.

We also find that the spending patterns are different only for the group of high-scrutiny firms (i.e., there is a threshold effect). Our estimates imply that the repatriation tax holiday induced, among such high-scrutiny firms alone, $0.41 of additional R&D spending per revenue dollar forgone by the Treasury under the Act.