Does corporate tax planning mitigate financial constraints? Evidence from China

Jie Sun, Lewis Makosa, Jinkun Yang, Fangyuan Yin and Lovemore Sitsha

International Journal of Finance & Economics, 2023, vol. 28, issue 1, 510-527

Abstract: We hypothesize that tax planning behaviour mitigates a firm's financial constraints, and this effect is more pronounced in non‐state‐owned enterprises and big firms compared to their counterparts. We use data for Chinese listed firms during the period 2010–2018 to test the hypotheses, based on both ordinary least squares and fixed‐effect models. The regression results show that tax planning is positively and significantly associated with mitigation of financial constraints, suggesting that cash tax savings are likely to improve firms' financial slack. This effect is stronger for non‐state‐owned enterprises, big firms, non‐political firms and firms in the eastern region of China. Further analyses reveal that, in the long run, tax planning increases firms' financial constraints, supporting Scholes‐Wolfson's point of view of tax planning, that minimizing taxes is not the same as effective tax planning. These results are robust to various tests. Overall, our results suggest that minimizing tax generally produces immediate cash flow benefits and mitigates financial constraints in the short run; however, in the long run, firms should adopt sustainable financing strategies.

Date: 2023
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