Tax enforcement and corporate cash holdings

Abstract

Strengthened tax enforcement increases firms’ expected tax liabilities and uncertainty; thus, firms have incentives to hold more cash. Considering the staggered implementation of a new tax system that increases tax enforcement across provinces in China as a quasi-natural experiment, we employ the difference-in-differences method to test the above prediction. The results indicate that stricter tax enforcement is associated with greater corporate cash holdings. This effect is stronger for financially constrained firms and those located in areas with high tax noncompliance penalties. Additionally, tax enforcement increases firms’ propensity to accumulate cash from cash flows and decreases capital expenditures and dividend payouts. The main findings are robust to the stacked difference-in-differences method, alternative cash holding measures and different sample selections.