Why some companies might not want to outsource tax planning

Credit: Dan Page

Ed Finkel | Apr 05, 2019

Sections Accounting

Given corporate America’s relentless pursuit of outsourcing and downsizing over the last few decades, it’s fair to ask whether tax departments will be next. Indeed, business bellwether General Electric moved its tax department to PwC in 2017. 

But research by Chicago Booth’s John Barrios and John Gallemore suggests that outsourcing tax departments won’t help some businesses. Because tax strategies often need to be tailored to a company’s specific needs, there’s potentially little to be gained and much to be lost from trying to outsource their development, and companies would be better off investing in tax-related human capital.

During the study period—1999 through 2015—US companies had a 35 percent tax on adjusted profits. (The rate has since been cut to 21 percent.) This gave corporations a tremendous incentive to lower their taxes using legal strategies such as shifting income and exploiting tax credits. In fact, many companies paid a substantially lower effective tax rate, or ETR, than the statutory rate. 

To document how personnel shifts affected companies’ tax liabilities, the researchers constructed a database of almost 65,000 individuals by culling résumés on LinkedIn posted by tax-department employees of companies in the S&P 1500. This group consisted of publicly traded enterprises included in the S&P 500, the S&P 400, and the S&P 600. Barrios and Gallemore focused on almost 4,000 people who moved between companies.

The résumés revealed the tax pros’ employment histories and enabled the researchers to analyze their human capital—their skills and knowledge, such as the ability to interpret tax law, handle uncertainties inherent in complex corporations, and strategically craft and implement tax strategies. Fifty-six percent of the tax experts began their careers at S&P 1500 companies, 25 percent came from public-accounting firms, and 21 percent were from other organizations. 

The research finds that companies tended to hire from peers of similar size, geographic area, industry, and multinational presence, suggesting that companies may require specific expertise—which may not be available if outsourced.   

Moreover, corporations went farther afield in recruiting when their ETR was higher than those in the bottom quartile, an indication that companies needing to lower their rate were willing to incur greater search costs. And indeed, those that snagged tax pros from businesses that had been more successful at lowering their rate generally saw their own annual ETR fall by 1–2 percentage points.

The researchers caution that their data are potentially limited by the voluntary nature of the LinkedIn résumés they sourced, as well as by errors or biases the documents may have contained. The findings also don’t measure causality, they write. 

Nonetheless, their research could have implications for understanding and projecting corporate investments in tax-department human capital. As a company’s goal is to maximize after-tax profits, businesses need tax pros to help create tax policy, not just fill out tax returns, Barrios says.