How Much of the Recent Evidence of a Corporate Tax Shelter Problem is Explained by Increased Stock Option Activity?

Abstract

According to the Treasury Department, a principal piece of evidence of the existence of a corporate tax shelter problem is the faster recent growth of corporate book income relative to taxable income. This paper attempts to determine whether, and to what extent, increased stock option activity is the explanation for this phenomenon. I first estimate the amount of the decline in the corporate effective tax rate and the size of the hypothetical "corporate tax gap" in 1998 resulting from the different growth rates of book income and taxable income. Then, based upon financial information of the corporations comprising the Standard & Poor's 100, I further estimate that a significant portion, but less than half, of the gap was attributable to increased stock option activity.

Keywords: Corporate Tax Shelters, Stock Options, Book Income, Effective Tax Rate, Taxable Income, Corporate Tax Gap

JEL Classification: H20, M41