As Uncertain as Taxes

Does room for interpretation in the tax law affect corporate financial decisions? To be widely applicable, tax law has to leave room for interpretation, which creates what is known as ’legal uncertainty’. Companies can use this ’legal uncertainty’ for tax planning, or use debt as a relatively certain tax planning tool. I construct a measure of ’legal uncertainty’ and show that this ’legal uncertainty’ leads to a substitution between debt-based and other tax planning strategies. I find that both financing and profit shifting are affected. The strength and direction of this effect depends on the intensity of the enforcement by the tax authority.