Reciprocity in Corporate Tax Compliance—Evidence from Ozone Pollution

• Published date: 01 December 2023
• Author: TRAVIS CHOW,ZHONGWEN FAN,LI HUANG,OLIVER ZHEN LI,SIMAN LI
• Date: 01 December 2023
• DOI: http://doi.org/10.1111/1475-679X.12500

DOI: 10.1111/1475-679X.12500

Journal of Accounting Research

Vol. 61 No. 5 December 2023

Printed in U.S.A.

Reciprocity in Corporate Tax

Compliance—Evidence from Ozone

Pollution

TRAVIS CHOW,∗ZHONGWEN FAN,†LI HUANG,‡

OLIVER ZHEN LI,§,∗∗ AND SIMAN LI

Received 22 March 2021; accepted 8 April 2023

ABSTRACT

In a tax—public goods reciprocity framework between citizens and the state,

managers view taxes as a payment to the government in exchange for pub-

lic goods, and hence they adjust their willingness to pay taxes as public good

quality changes. We show that corporate tax planning intensity increases with

ground-level ozone pollution. Revisions in ozone pollution regulations cause

counties that failed the revised and more stringent standards to reduce ozone

∗HKU Business School, University of Hong Kong; †Department of Accountancy, City Uni-

versity of Hong Kong; ‡Department of Accounting, Antai College of Economics and Man-

agement, Shanghai Jiao Tong University; §School of Accounting, Shanghai Lixin University

of Accounting and Finance; ∗∗Department of Accounting, National University of Singapore;

Accounting Department, Xiamen University

Accepted by Christian Leuz. We are grateful to an anonymous associate editor and an

anonymous reviewer for insightful comments that helped signif‌icantly improve the paper.

We thank Pingyang Gao, Kelvin Law, Kay Xiao, and colleagues and workshop participants

at National University of Singapore, City University of Hong Kong, University of Hong Kong,

and Shanghai Lixin University of Accounting and Finance for comments and suggestions. We

also thank Rui Shen for sharing the corporate culture data and Shufang Lai for sharing the

CEO birthplace data. TravisChow acknowledges support from HKU’s Seed Fund for Basic Re-

search. Oliver Zhen Li acknowledges support from the National Natural Science Foundation

of China (grant number 71972135) and Musim Mas Professorship. Siman Li acknowledges

support from the Fundamental Research Funds for the Central Universities (grant number

20720221053). All errors are ours. An online appendix to this paper can be downloaded at

https://www.chicagobooth.edu/jar-online-supplements.

1425

© 2023 The Chookaszian Accounting Research Center at the University of Chicago Booth School of

Business.

1426 t. chow et al.

pollution. Consequently, f‌irms headquartered in these counties reduced cor-

porate tax planning intensity relative to f‌irms in other counties. The ozone-

tax link varies in the predicted directions with public attention to pollution,

potential welfare loss due to ozone, managers’ stakeholder orientation, tax-

payers’ polluting status, political preferences, and civic norms. We also f‌ind

consistent results for Superfund cleanups of hazardous waste sites. Our re-

search sheds light on reciprocity as a potential mechanism inf‌luencing cor-

porate tax compliance.

JEL codes: H26, H41, Q51, Q53

Keywords: corporate tax; pollution; public goods; reciprocity; tax morale

1. Introduction

In public f‌inance, the government plays the dual role of collecting tax and

providing public goods that the private sector is not poised to supply eff‌i-

ciently. Prior research has focused on monitoring or enforcement efforts

from the tax authority as a driver of corporate tax compliance (Hoopes,

Mescall, and Pittman [2012], Almunia and Lopez-Rodriguez [2018], Slem-

rod [2019]). However, limited attention has been paid to mechanisms that

inf‌luence the morale of corporate tax compliance. Given that one funda-

mental goal of the tax policy is to sustain governments’ provisioning of pub-

lic goods such as air quality, people’s experience with the quality of public

goods can affect their perception of the fairness of the tax system and thus

their willingness to pay tax (Slemrod [2003], Luttmer and Singhal [2014]).

We consider reciprocity between citizens and the state (Besley [2020]) and

examine how corporate tax planning behaviors can be shaped by local air

quality, as measured by ground-level ozone concentration.1We show that a

higher ozone concentration leads to more intense corporate tax planning,

plausibly via a reciprocity mechanism.

Ground-level ozone is one of the most common air pollutants specif‌ied in

the National Ambient Air Quality Standards (NAAQS). Unlike other major

air pollutants that have decreased substantially over the past four decades

and are now at levels far below the national standards at a majority of tested

sites, ground-level ozone concentrations have remained persistently high.

Ozone can inf‌lame the lung airways and impair lung function in humans.

Medical research provides compelling evidence that both short- and long-

term exposure to ozone is associated with numerous immediate health

1Among public goods, air pollution reduction plays a central role in regulatory policies.

For example, the U.S. Off‌ice of Management and Budget [2017] notes that “across the Federal

government, the rules with the highest estimated benef‌its as well as the highest estimated costs

come from the Environmental Protection Agency (EPA) and in particular its Off‌ice of Air

and Radiation. Specif‌ically, EPArules account for 71 percent to 80 percent of the monetized

benef‌its and 55% to 64% of the monetized costs. Of these, rules that have a signif‌icant aim to

improve air quality account for over 95 percent of the benef‌its of EPA rules.”

reciprocity in corporate tax compliance1427

problems such as asthma attacks and early death.2Local ozone pollution

thus represents a welfare loss to affected residents.

Experiencing poor public goods quality can induce a perception of the

unfairness of the tax system and discourage tax compliance. Based on a

contractarian view of the state-citizen relationship (Locke [1690], Rousseau

[1762]) in which reciprocity plays a central role in tax compliance, by pay-

ing tax, people entrust the provision of quality public goods to the govern-

ment (Levi [1988, 1998], Luttmer and Singhal [2014]). As the government

plays the dual role of a tax collector and a spender of tax revenue, how eff‌i-

ciently and responsibly it deploys revenue, as ref‌lected in the quality of en-

vironmental public goods, can affect citizens’ tax morale. This state-citizen

reciprocity is formally modeled by Besley [2020], who shows that citizens re-

spond to government’s provisioning of public goods by reciprocally paying

tax.

The reciprocal motive in tax compliance is consistent with laboratory ev-

idence showing that participants are less likely to avoid taxes if they benef‌it

from the public goods that their tax payment supports (Alm, McClelland,

and Schulze [1992], Alm, Jackson, and McKee [1993]). Field experiments

using text messages to manipulate taxpayers’ view about public goods ren-

der mixed results, due to the diff‌iculty of using mere words to intervene

ones’ experience with public goods (Luttmer and Singhal [2014]). Large

sample empirical evidence in support of the substantiality of reciprocity in

tax compliance is still lacking. Notably, prior research on reciprocity has

mostly focused on individual taxpayers. Whether corporate taxpayers re-

spond to the quality of public goods remains unexplored.3

We focus on the ozone pollution setting to test the notion of reciprocity

in corporate tax compliance. Owing to its persistence and negative public

health consequences, ozone pollution likely represents a strong interven-

tion that can inf‌luence citizens’ perceptions about public goods quality,

government eff‌icacy, and hence their attitudes toward paying taxes.4Fur-

ther, the ozone pollution setting affords us distinct empirical advantages.

In the United States, ozone concentration is measured at the county level

in a consistent and reliable manner, which provides county-year variation

of public goods quality for a large sample. More importantly, regulatory

revisions in ozone standards by the EPA enable us to identify the effect of

public goods quality on tax behaviors in a difference-in-differences (DiD)

framework.

We argue that managers’ experience with public goods affects their cor-

porate tax decision making via a reciprocity mechanism. We spell it out

here: Managers substantially inf‌luence corporate tax planning by setting

the tone for f‌irms’ tax planning behaviors (Dyreng, Hanlon, and Maydew

2Online appendix A provides more background on ozone pollution.

3See online appendix B for a literature review on the role of reciprocity in tax compliance.

4See online appendix C for anecdotal evidence on citizens’ blame to the government for

ozone/air pollution problems and their discouraged tax morale in reciprocity.