Companies take various measures to reduce their tax burdens—including setting up in countries charging lower rates or working with certain banks.

Many may also go on end-of-fiscal-year shopping sprees in an attempt to minimize taxes, suggests research by University of Illinois’s Qiping Xu (a recent graduate of Chicago Booth’s PhD Program) and Booth’s Eric Zwick. Their work provides more evidence of how taxes can affect corporate decision-making.

The spending pattern isn’t immediately evident, in part because companies have different fiscal years. Xu noticed it when parsing the data for a different project, and then grew curious about what seemed like a data anomaly. The researchers wondered, did the pattern show companies trying to minimize their tax bill by spending late in the year?

When companies invest in capital goods, they can start charging off depreciating equipment against profits, reducing taxable income. The allowable depreciation deductions are spelled out in tax rules, and there’s an incentive to invest near the end of the fiscal year because a company can realize future deductions early. “Our research design exploits this feature and the sharp behavior it induces to separate investment responses driven by the tax code from other confounding factors,” the researchers write.

Xu and Zwick looked at Compustat data on most US companies from 1984 to 2013— excluding small companies, financial companies, and utilities. Because companies typically report accumulated spending, the researchers backed out quarterly spending. Doing so, they saw that average fourth-quarter capital outlays exceeded average capital spending in the first three quarters by 37 percent. Analyzing data from 33 countries, they observed a similar pattern of higher fourth-quarter spending.

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Drilling into the US data, they looked at what happened after the Tax Reform Act of 1986 reduced the marginal incentive to spend at the end of the year by, among other actions, repealing a generous investment tax credit. When the law went into effect, companies decreased their average fourth-quarter spending by 5–10 percentage points, which suggests they had been spending at least in part to minimize their tax bills.

The research also indicates that companies have an “option value motive” to delay spending until the end of the fiscal year, because they can wait until then to see where they are positioned taxwise and can then make a decision about whether purchasing will pay off in terms of minimizing taxes. The better business has been and the more taxes companies expect to owe, the greater the incentive for capital investment. It helps that for tax-deduction purposes, year-end investments are treated as if the capital goods had been put into use at midyear, thus magnifying the tax benefits, and providing more incentive for a late shopping spree.

The researchers acknowledge that there are other potential fourth-quarter spending factors besides tax minimizing, including a race to use up budgets. In many companies, future accounts can be set lower if budgets aren’t spent, and a leftover budget could have a negative effect on evaluations of employee or manager performance.

However, there are ramifications for the interplay between tax policy and spending. Lawmakers proposing tax changes often invoke purported benefits for the economy. The pattern of year-end investment spikes that Xu and Zwick document ripples through industries supplying capital goods, as orders dry up in the first quarter and producers are forced to build up speculative inventories each year in anticipation of a fourth-quarter rush. This behavior could affect the efficacy of tax changes.

Xu and Zwick caution against concluding too much about the effect of taxes on aggregate investment. But they also offer a lesson for future corporate tax policy.

“Our findings show that tax incentives that directly target investment expenditures have pronounced effects on investment planning decisions for even the largest firms in the economy,” they write. “These effects are driven especially by how the code treats expenditures in the year of purchase. Policymakers may want to consider these factors as they debate the relative merits of proposals that lower corporate tax rates while slowing depreciation deductions versus proposals that accelerate depreciation deductions.”

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