Does tax avoidance increase or decrease when tax enforcement is stronger? Evidence using CSR heterogeneity perspective

Prior literature has reported mixed results on whether corporate social responsibility (CSR) activities are associated with more or less tax avoidance. These past results may be attributed to a failure to control for endogeneity between tax avoidance and CSR. We utilize an exogenous increase in tax enforcement to investigate how a heightened level of scrutiny by authorities affects tax avoidance by firms adopting CSR policies (CSR firms) compared to non-CSR firms. If stronger enforcement leads to greater tax compliance, we expect to observe a decline in tax avoidance measures in all firms. As expected, tax avoidance has decreased in non-CSR firms in response to this exogenous change, but surprisingly, in CSR firms it has increased. The results are supported by theories such as the licensing effect and organized hypocrisy. We contribute to the literature by using an exogenous shock to tax enforcement to shed light on whether CSR firms act in a socially responsible manner in their tax reporting. Moreover, we provide new empirical evidence relevant to the theory of organized hypocrisy, whereby there are notable inconsistencies between the actions that corporations take to bolster their public image and self-serving practices. • We use a natural experiment to test how firms respond to increased tax enforcement. • We test if Corporate Social Responsibility (CSR) firms respond differently to stronger tax enforcement than other firms. • If stronger enforcement leads to greater tax compliance, we expect to observe a decline in tax avoidance in all firms. • In contrast to non-CSR firms, CSR firms increase tax avoidance efforts in response to stronger tax enforcement. • These results are supported by theories such as the licensing effect and organized hypocrisy.