How Do Labor Adjustment Costs Affect Corporate Tax Planning? Evidence from Labor Skills

Labor adjustment costs (LACs) are a broad concept and involve costs incurred to search, hire, train, retain, and fire employees. LACs represent a substantial financial burden for firms, and increase with their reliance on skilled labor for production and operation. In this study, I examine whether firms save more cash taxes in anticipation of future cash-flow difficulties due to the sheer and rigid LACs. Using the level of labor skills as a proxy for LACs, I find that higher LACs are indeed associated with greater tax savings. The effect is stronger for firms facing more intense competition, and firms in states that strengthen labor protection, but weaker for firms in states that restrain labor mobility. High-LAC firms avoid taxes to generate precautionary cash, and this behavior is amplified for financially constrained firms. I improve the causal interpretation by exploiting the 2005 Hurricane Katrina as an exogenous LAC shock. Collectively, the evidence indicates a significant influence of frictions in labor markets (i.e., LACs) on corporate tax planning behavior