Corporate Tax Evasion: Evidence from International Trade

Abstract

This paper investigates how firms misreport their imports and exports to evade corporate income taxes (CIT). I propose a simple model where in response to a CIT rate increase, firms under-report exports (sales) to lower taxable profits. The same firms wish to over-report imports (costs) to further lower reported profits, yet may prefer to under-report imports together with exports to minimize inconsistencies in income statements that heighten the risk to be audited. The condition dictating which behaviour is optimal depends on observables, and thus offers reduced-form testable predictions. Trading partners located abroad - which are not impacted by the tax change - report the same trade flows to their own authorities, yet do not have the same incentives to misreport. I find strong empirical support for the model predictions based on correlations between tax rates and mirror statistics of trade flows between countries at the product level. Firms appear to under-report exports to lower taxable profits upon an increase in the CIT rate, while their choice to either under- or over-report imports depends on country, industry, and product characteristics as predicted in the model. I also show that firms misreport trade flows to shift profits across years in a manner suggesting evasion motives. Multinational firms appear less likely to engage in these evasion strategies, although they account for a large share of trade volumes.