The Effect of Changes in State Tax Rates on State, Federal and Foreign Tax Planning

We examine whether and to what extent changes in state corporate statutory income tax rates (STRs) affect firms’ income tax burdens. We provide the first evidence that there is a federal tax burden shifting response to increased STRs. After adjusting for the federal deductibility of state taxes, we find that following STR increases, companies decrease federal effective tax rates and maintain stable overall effective tax rates. Results are concentrated in firms with constrained tax planning options, including domestic-only firms, firms with strong bonds to their headquarter state, firms in headquarter states with severe corporate tax penalties, and firms in states with low state and federal tax conformity. Overall, our results suggest that focusing only on total effective tax rates may obfuscate important insights gained from separately considering federal, state, and foreign tax components. Our study provides evidence of an unintended consequence of state corporate tax increases, which should be of interest to tax authorities and legislators.