Taxes, Competition, and Organizational Form

This study examines whether competition from tax-advantaged firms influences the organizational form choice of rival tax-disadvantaged firms, and explores two outcomes of this choice. Using a sample of 5,268 predominantly private U.S. commercial banks during 1997-2010, we find that greater competition from S corporation banks, which are subject to one layer of income tax, increases the likelihood that rival C corporation banks, which are subject to two layers of income tax, convert to S status. We estimate that the aggregate first-year tax savings from S conversion exceed $267 million, which converting banks can use to maintain competitive parity with their rivals. In terms of outcomes, converting banks increase their deposit market share more than non-converting banks, with advertising growth and new bank branches facilitating this increase. Non-converting banks increase their tax avoidance. Our findings provide economic insight into how competition shapes — and is shaped by — taxes and organizational form