The statement ‘Business goes global, taxes stay local’ typically expresses the critical issues in business practice, policymaking, and research. While every country operates under different tax rules, businesses have grown to operate globally, increasing their compliance cost, as they must comply with several tax laws. However, this allows the companies to minimize their tax burden by shifting profits to countries with favorable tax rules. Tax avoidance has become a primary public concern in recent years, attracting the interest of scholars and practitioners. This paper aims to define tax avoidance and evaluate why the topic has received interest from academicians and practitioners. The paper also examined the link between Chief Executive Officer (CEO) overconfidence and corporate tax avoidance and ascertained that overconfident CEOs are often involved with aggressive tax planning. Therefore, despite countries’ efforts to set favorable tax laws, tax avoidance remains one of the major bottlenecks in the system and is common in both developed and developing countries.
Although no statutory definition of tax avoidance exists, scholars define it as exploiting loopholes in tax legislation to minimize the tax burden effectively. Sutrisno et al. (2022) define tax avoidance as the legal process of minimizing an individual’s or a company’s tax liability using legal strategies. Tax avoidance is usually considered a distinct opposite of tax evasion, which entails the illegal and deliberate effort to enjoy tax benefits by subverting the rule of law. Many taxpayers worldwide employ tax avoidance strategies to minimize their tax burden and maximize their disposable income. This can be achieved by taking advantage of allowances, exemptions, credits, and other tax benefits. It can also be achieved by prioritizing investments with tax benefits, such as purchasing tax-free municipal bonds. However, despite the difference in their legality, tax avoidance and tax evasion have significant fiscal effects on the economy. They result in a portion of taxpayers reducing their tax liabilities while the others pay a greater share of the collective tax burden.
Tax avoidance has recently gained worldwide attention as the aggressive strategies used by multinational companies to avoid tax increasingly come to light. Several studies have examined how high-profile conglomerates have minimized or wholly avoided tax through strategic accounting mechanisms such as transfer pricing and strategic tax plans, including setting up shell companies using tax havens to avoid taxes. Complex and outdated tax codes, the rapid growth of the informal economy, and the lack of proper tax law enforcement also support it. Arguably, tax avoidance remains an excellent conundrum for academicians and practitioners considering the magnitude of its ethical and economic implications.
According to Dyreng et al. (2010), tax avoidance may result in a devastating loss of a country’s Gross Domestic Product (GDP) at the micro level and has therefore become a significant and debatable concern for academics, practitioners, and tax collector authorities. According to the UK tax collection agency HMRC, the overall cost of tax avoidance in the UK was 1.7 billion pounds in 2017, with over 0.7 billion coming from the loss of income tax, while the rest came from the loss of corporate tax other direct taxes. Another study by Alleyne and Harris (2017) ascertained that many countries face the challenge of meeting annual budgets due to the deficit created by tax avoidance and tax evasion. The study also concluded that tax avoidance is more prevalent in developing countries because these countries cannot control it. Many countries, including the United Kingdom, South Africa, and Australia, have enacted laws prohibiting aggressive tax avoidance, known as General Anti-Avoidance Rule (GAAR). These rules provide governments with the resources to constrain all schemes developed to explore various loopholes in tax laws.
It is also essential for academicians and practitioners to critically examine tax avoidance since the topic has received limited attention in the tax law field despite its significant impact on the world economy. Tax avoidance is motivated by various economic factors, including tax fairness, compliance cost, and tax system. However, further studies reveal that behavioral factors, including tax morale and other sociodemographic factors, may fuel tax avoidance. Consequently, since tax is charged against profits, most managers may plan the company’s activities to minimize the impact of taxes on company finances. Companies and individuals who participate in tax avoidance have been criticized by different groups and studies considering the economic impact on a country. Some scholars consider tax avoidance as a technicality in the tax collection system. However, psychologists believe that tax avoidance is a social problem.
Overconfidence is a concept that closely relates to a CEO’s perception of his abilities. The concept is deeply rooted in psychology but has gained immense attention in accounting and economics. Overconfidence deals with the tendency of individuals in power to overestimate their abilities regarding characteristics such as predictions, forecasts, and judgment (Chyz et al., 2014). The term overestimation is usually interchanged with over-optimism. However, the core difference can be inferred in that overconfidence stems from an individual’s self-assessment, while the latter relates to the assessment of external factors. However, the concept can better be viewed from a two-dimensional approach, over-optimism, and miscalibration. The over-optimism approach comprises the ‘better than average syndrome and the control effect illusion. The overly optimistic nature can stem from the illusion of controlling uncertain events. However, these events are usually uncontrollable since most originate from the external environment, warranting proper management. Usually, overconfident CEOs tend to overestimate their abilities and capabilities without considering the odds and certainty of events.
The miscalibration dimension focuses on uncertainty outcomes. CEOs miscalibrate by making unrealistic underestimations when making predictions or forecasting. In relation to CEOs, miscalibration can be seen from the angle of risk in decision-making and is most evident in over-confident CEOs who tend to underestimate uncertainty and are prone to risky decisions. Therefore, overconfidence is a behavioral tendency closely associated with decision-making. According to upper echelon theory, overconfidence is a trait that, if exhibited by CEOs, may significantly affect strategic decisions. Specifically, tax avoidance is a risky business with severe implications and penalties. However, overconfident CEOs are likely to miscalibrate the possibility of being caught or overestimate their ability to draw aggressive tax plans that would not be detected. The echelon theory also asserts that CEOs act based on their perception of the strategic environment, which is rooted in their personality, experience, and values (Sutrisno et al., 2022). Therefore, the attributes of a CEO are expected to individually or collectively affect their tax avoidance behavior as a strategic outcome.
The chief executive officer is the shareholder’s primary agent, tasked with overall decision-making, and is naturally expected to show confidence. The hypothesis is that confident managers tend to be promoted over those that do not dramatically contribute to overconfidence. In addition, overconfidence has been linked to the desire for risky investments, which highly depends on the availability of funds. As such, overconfident CEOs need to generate income that meets their expectations while allocating more resources for business expansion and additional investment. Therefore, CEO overconfidence and tax avoidance practices are significantly related since these practices may provide additional finances to the company. Overconfident CEOs are more likely to partake in international mergers and acquisitions, especially in countries with favorable tax rules and lower tax rates (Lartey et al., 2022). They use tax avoidance to try and confirm their ability to minimize taxes, improve their reputation, and collect financial funding.
In financial accounting literature, studies document that CEO overconfidence substantially impacts probabilistic estimates in financial accounting. As such corporate tax policies provide an appealing setting to study the concept of CEO overconfidence since estimating future outcomes is ambiguous and requires managerial discretion (Wang et al., 2020). In tax literature terms, despite the new standards to increase the consistency of tax uncertainty, CEO overconfidence provides diversity in financial reporting reducing the faithful representation and comparability of undeclared tax estimates. This increases the possibility of tax avoidance practices in the presence of overconfident CEOs. According to Scholes and Wolfson’s (1992) all parties, taxes, and costs framework, while aggressive corporate tax policies generate tax savings, they are not costless. The non-tax cost associated with aggressive corporate tax policy includes reputational penalties and tax strategy implementation costs. Consequently, the CEOs must trade off these costs with the expected benefits from aggressive policies.
In this study, we explore the concept of tax avoidance and advance the literature by examining the link between CEO overconfidence and corporate tax avoidance. Tax avoidance is the legal process of minimizing an individual or company’s tax liability by exploring legal loopholes in tax legislation across different nations. The concept of tax avoidance has gained significant attention since countries worldwide depend on taxes to sustain their economies and deliver essential services. It is motivated by various factors, including tax morale, tax system, compliance cost, and tax fairness. The study also critically examined the link between CEO overconfidence and corporate tax avoidance, establishing that overconfident executives are more likely to engage in aggressive tax policies. The concept is best viewed from a two-dimensional approach, over-optimism, and miscalibration.
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