Does the Disclosure of Tax Payments Create More Transparency?

Why mandating the public disclosure of bottom-line tax numbers may backfire

Bart Diernyck / Martin Jacob / Maximilian Müller / Christian Peters / Victor van Pelt  - June 18, 2021

To reveal to the public whether firms pay their “fair share,” policymakers and regulators increasingly require firms to disclose how much taxes they pay. The research study, “Public Tax Disclosures and Investor Perceptions,” finds that such disclosures can be misleading: Not all firms that pay little taxes (e.g., startups) are necessarily ”bad“ corporate citizens, but the details get lost more easily when disclosures emphasize tax payments only.

Policymakers and regulators have long debated whether to mandate the public disclosure of corporate tax payments. Proponents argue that such forms of corporate tax transparency encourage firms to pay their “fair share” of tax, improve accountability, and allow the public to act against aggressivetax avoiders. Opponents argue that mandating these disclosures creates compliance burdens for firms and forces them to divulge sensitive, proprietary information to competitors. Leaks and scandals, such as LuxLeaks and the Paradise Papers, have illustrated that many firms can still withhold tax-related information from public scrutiny. These incidents have increased the call to halt aggressive tax avoidance and led to debates on achieving this. Next to the global minimum tax rate recently proposed by global leaders at the G7, mandating the public disclosure of corporate tax information is one of the key instruments for policymakers and regulators to improve corporate tax compliance.

Milestone deal for corporate tax transparency

At the beginning of June 2021, EU lawmakers struck a milestone deal for corporate tax transparency after years of deadlock. The deal requires large multinational corporations to disclose profits and tax payments in each EU country and several tax-havens. However, the EU is not the first to mandate public tax disclosures. In 2013, the Australian government enacted a law that mandated the Australian taxation office to disclose for large firms how many taxes they effectively paid in Australia.

The idea behind this type of policy is simple: If the public has easier access to how much corporate taxes firms pay, then it should be easier for them to identify aggressive tax avoiders and distinguish them from less aggressive ones. One important stakeholder group is retail investors because they may choose to divest or refrain from investing in firms that do not pay their fair share of taxes in their country while prioritizing investing in firms that do. This prospect could, in theory, lead firms to restrict themselves to less aggressive tax avoidance methods.

Retail investors may misinterpret the disclosed information

However, anecdotal evidence from Australia suggests that retail investors and other members of the public may misinterpret the information featured in these public tax disclosures. For instance, the media picked up on the public tax disclosures in Australia and reported to the public that Qantas Airways had not been paying tax for almost ten years. However, Qantas paid zero taxes in Australia because it suffered losses during the financial crisis and used tax loss carryforwards. Governments tend to offer tax loss carryforwards to offset losses against future profits, which is one way to lower corporate taxes legitimately. This raises the question of whether important members of the public, such as retail investors, can disentangle firms that reduce taxes using legitimate means from firms that aggressively avoid taxes and whether public tax disclosures may help or hinder retail investors in doing so.

A recently conducted research study aims to answer this question. Specifically, it examined the impact of mandating the public disclosure of corporate tax payments on retail investor perceptions. The study features a hypothetical firm that paid corporate taxes below the statutory rate in a particular jurisdiction and asked retail investors whether this firm paid its “fair share.” However, it varied how this firm lowered its corporate taxes. It either used less aggressive means (i.e., tax credits offered in the firm’s primary jurisdiction) or more aggressive means (i.e., it shifted profits from its primary jurisdiction to a tax haven). It also distinguished whether the primary jurisdiction had a public tax disclosure policy in place that required the firm to separately and publicly disclose corporate tax payments in that jurisdiction. Although retail investors could always uncover how the firm lowered its corporate tax payments, they separately received information about the firm’s corporate tax payments in its primary jurisdiction in the presence of the public tax disclosure policy.

The figure above displays the main finding of the study. Specifically, mandating the public disclosure of corporate taxes can make it more difficult for retail investors to differentiate among firms. Specifically, in the absence of the public tax disclosure policy (LHS), retail investors differentiate among firms because they spend more time uncovering how the firm lowered its corporate tax payments in its primary jurisdiction. However, this differentiation disappears in the presence of the public tax disclosure (RHS). Additionally, the lack of differentiation subsequently affects retail investors’ willingness to invest in the firm.

The results suggest that retail investors unconsciously over-rely on the corporate tax payments central to the public tax disclosure. The public tax disclosure makes these bottom-line tax numbers more accessible to retail investors, leading them to rely less on other sources of information which may also help them infer whether the firm aggressively avoids taxes. These other sources of information could be information contained in financial statements, other financial disclosures, or tax information originating from other tax jurisdictions.

What can policymakers and firms do?

Although the study provides a cautionary note to policymakers and regulators, it also presents a way forward. That is, if retail investors realize that the disclosed information is only a limited proxy for whether the firm pays its fair share of taxes, they may not be so quick to judge firms on this proxy alone. If regulators and policymakers, such as the EU, choose to mandate public disclosure of select tax information, they should make it clear to the public that the information is most likely incomplete. Also, if firms find themselves subject to having to disclose select pieces of tax information, they could choose to voluntarily disclose transparency reports that explain why their corporate taxes may differ from the statutory tax rate.

Literature reference and methodology

The study “Public Tax Disclosures and Investor Perceptions” discussed in this article is conducted by Prof. Dr. Bart Dierynck, Prof. Dr. Martin Jacob, Prof. Dr. Maximilian Müller, Christian Peters MSc, and Dr. Victor van Pelt. The study examines changes in the perceptions of 421 retail investors in response to public tax disclosure.

• Dierynck, B./Jacob, M./Müller, M./Peters, C./van Pelt, V. (2021): Public Tax Disclosures and Investor Perceptions. Available at http://dx.doi.org/10.2139/ssrn.3729938

Authors