Implicit Taxes in Imperfect Markets

Abstract

This research addresses the question of whether market competition influences a firm's implicit tax burden. Implicit taxes are defined as the pretax rate of return disadvantage earned on an investment that is taxed preferentially. The Scholes and Wolfson (1992) model predicts that implicit taxes will fully offset any benefit from preferential tax treatment leading to no benefit from lower explicit taxes; however, their theory assumes perfect market competition. This chapter relaxes the assumption of perfect market competition and finds that firms in industries with lower competition bear lower implicit taxes and firms in industries with higher competition bear higher implicit taxes. These findings are consistent with monopoly and oligopoly behavior predictions where firms in less competitive industries have greater price setting power and can retain more of their tax savings while market forces in competitive industries force companies to pass along any savings to customers (Mason, 1939). Furthermore, these findings answer the call in the literature for more research on determinants of cross-sectional variation in implicit taxes (Shackelford & Shevlin, 2001).

Citation

Smith, H. (2021), "Implicit Taxes in Imperfect Markets", Hasseldine, J. (Ed.) Advances in Taxation (Advances in Taxation, Vol. 29), Emerald Publishing Limited, Leeds, pp. 1-24. https://doi.org/10.1108/S1058-749720210000029001