The impact of financial constraints on banks’ cash tax avoidance

Abstract

Purpose

The purpose of this paper is to investigate whether and how banks’ financial constraints affect their cash tax avoidance. The authors hypothesize that banks engage in more tax planning to generate additional cash to mitigate their financial constraints.

Design/methodology/approach

The authors use a sample of US banks to conduct the panel regression analysis. The authors measure the bank tax avoidance using the cash effective tax rate and measure the bank financial constraints using the Z-score and annual payout ratio. The authors further use the implementation of the Dodd–Frank Act as a quasi-natural experiment to conduct the difference-in-difference analysis.

Findings

The authors document that financially constrained banks exhibit lower cash effective tax rates. The authors further show that banks facing greater financial constraints are less likely to pursue tax-saving activities following the Dodd–Frank Act. Moreover, the authors find that non-performing loans increase the influence of financial constraints on tax avoidance, while a financial crisis amplifies the impact of financial constraints on bank cash tax savings.

Originality/value

By extending previous research on financial constraints and tax planning, this paper is the first study to recognize financial constraints, along with the Dodd–Frank Act, as determinants of banks’ tax avoidance. This study informs policymakers about the regulation of tax avoidance in the banking industry and sheds light on possible future research on banks’ tax-planning strategies.