Explaining Underutilization of Tax Depreciation Deductions: Empirical Evidence from Norway

Abstract

Many corporations do not claim all of their allowable tax depreciation deductions, despite apparently incurring a higher tax cost. There are several possible explanations. First, we find strong evidence that firms facing current tax losses or carrying forward past losses under-utilize depreciation in order to recover tax losses before they expire. Second, corporations with bad economic performance tend to under-utilize their deductions, suggesting that corporations use costly "window-dressing" on their accounting measures. Third, we find support for the hypothesis that tax compliance costs discourage the utilization of accelerated depreciation, especially by small firms. We do not find much support for other hypotheses. For example, we find no evidence of substitution between tax depreciation and private debt due to competition between the benefits of private bank monitoring and the tax savings from using tax allowances to postpone tax payments, as suggested in earlier literature. We also study the effects of the uniform reporting accounting system (typical of many European countries) which can, under certain circumstances, constrain dividends. The dividend constraint can be loosened by forgoing some tax depreciation, but the evidence does not support this motivation. Unusual access to extremely detailed individual firm tax returns forms in Norway made our empirical analysis possible. In addition, the 1992 Norwegian tax reform provided a natural experiment for testing some of the hypotheses. We use the time-series and cross-sectional variation across Norwegian corporations in 1988, 1991, 1992 and 1993.