Federal Corporate Tax Enforcement and Local Business Activity

We examine the consequences of federal corporate tax enforcement for local business activity. U.S. corporate tax return audits have declined significantly in recent years, and recent policies target expanding the number of tax return audits to improve tax revenues. However, tax audits can impose tax and non-tax costs on businesses and have spillover effects on non-audited firms, potentially reducing firm growth. Using cross-sectional variation in U.S. commuting zones’ exposure to firms of different sizes and time-series variation in tax return audit rates across firm size groups, we document that corporate tax enforcement is negatively associated with local business activity, as measured by establishments and employment. These findings are robust to a shift-share specification, falsification tests, and other research designs that address endogeneity and measurement issues. Furthermore, we find the impact of corporate tax enforcement on business activity is stronger in regions in which firms may face higher compliance costs and in which spillover effects between firms are more likely to occur. Finally, we find that the negative association between tax enforcement and business activity is increasing in regional exposure to likely tax avoiders and tax avoidance incentives. Overall, our findings suggest that corporate tax enforcement has both level and distributional consequences for business activity