# AN ANALYSIS OF PROPERTY-CASUALTY INSURERS: Tax Variables 2

ETR also is modified to assess the sensitivity of tax avoidance to insurance lines. EASYETR is ETR for the insurers writing greater than 75 percent of their business in lines other than automobile, farm, fire, home, and workers’ compensation and zero for other insurers. Specifically, these insurers concentrate their business in liability, medical malpractice, reinsurance, and credit and surety lines. EASYETR’s coefficient is expected to be negative, consistent with increased tax management in lines with more opportunities for Schedule T crossstate allocations. The first four lines involve insured property confined largely to a single state. Workers’ compensation is the most tightly regulated line of insurance. In fact, some states require its purchase from state workers’ compensation funds. Consequently, insurers have limited opportunity to allocate workers’ compensation insurance across states. payday loans online no credit check

# AN ANALYSIS OF PROPERTY-CASUALTY INSURERS: Tax Variables

The ideal tax measure is the marginal tax rate each property-casualty insurer faces in each state. Unfortunately, the data do not permit such fine calibrations. Instead, we employ two alternative measures to approximate marginal tax rates: the effective (or average) state tax rate on insurers and the estimated statutory (premium and income) tax rates. To determine the relevant tax rate for each insurer-state, insurers’ unique retaliatory tax structure must be incorporated in the tax measures. Thus, the insurer-state tax rate is the greater of the tax rate in the state where the insurance is sold and the tax rate in the state where the insurer is incorporated.4 Negative coefficients on the tax measures are consistent with tax management of the annual statements.

# AN ANALYSIS OF PROPERTY-CASUALTY INSURERS: Research Design

Dependent Variable

To determine whether multistate insurers avoid state taxes through strategic allocations in the statutory reports, insurance prices are regressed on measures of state taxes, controlling for previously documented price determinants:

PRICEij = \$0 + \$1 tax measuresij + \$2 control variablesj + control variablesi + eij for all insurers i and states j.

# AN ANALYSIS OF PROPERTY-CASUALTY INSURERS: Background and Hypothesis Development 3

States provide little guidance concerning the allocation process. The process is sufficiently murky that Harrington (1984, 614) contends any state allocations “depend on arbitrary assumptions that might make the resulting figures meaningless.” Private discussions with state revenue officials suggest tax audits primarily focus on determining whether all income is reported in some state. The allocations across states, which enable income shifting and are the focus of this study, reportedly receive less attention. Limited allocation regulations and enforcement lead to the paper’s hypothesis, stated in its alternative form:

# AN ANALYSIS OF PROPERTY-CASUALTY INSURERS: Background and Hypothesis Development 2

Four states (Florida, Illinois, New Hampshire, and New York) tax the profits of all property-casualty insurance companies underwriting within their borders. Connecticut, Kansas, and Oregon only tax the income of insurers incorporated in their states. The remaining states (and Connecticut, Kansas, and Oregon if the insurer is incorporated outside their borders) tax insurers’ premiums. For both income and premium taxes, the applicable tax rate is the greater of the tax rate in the state where the insurance is sold and the tax rate in the state where the insurer is incorporated. This unique feature of insurance company taxation is known as retaliatory taxes (Petroni and Shackelford 1995).

# AN ANALYSIS OF PROPERTY-CASUALTY INSURERS: Background and Hypothesis Development

Consistent with income shifting to avoid state taxes, we find the price of property-casualty insurance is decreasing in state tax rates. The results are consistent with multistate insurers managing their annual accounting reports to shift premiums (losses) to more (less) favorably taxed states. Additional tests using insurers operating only in a single state corroborate this interpretation. No negative relation is detected for single-state insurers. Inferences are cautiously drawn; however, because we only examine 180 single-state insurers and they may differ from multistate insurers along other dimensions.

# AN ANALYSIS OF PROPERTY-CASUALTY INSURERS: Introduction 2

At least two prior studies identify and test for specific multijurisdictional tax plans. Collins, Kemsley, and Shackelford (1997) use data from U.S. tax returns to examine shipments of inventory from foreign parents to U.S. subsidiaries in the wholesale trade industry. Contrary to expectations, they find no evidence of transfer pricing abuses. Klassen and Shackelford (1997) show firms avoid taxes by shipping manufactured goods from states with favorable taxation. However, their inferences are limited because they rely on non-tax return data, aggregated at the state level.

# AN ANALYSIS OF PROPERTY-CASUALTY INSURERS: Introduction

This study extends our understanding of cross-jurisdictional tax planning by documenting reporting patterns in insurers’ state annual accounting reports that are consistent with tax-motivated income shifting. Specifically, our findings are consistent with property-casualty insurers avoiding state taxes through strategically allocating premiums and losses across the statutory reports they file with each state in which they operate. Although the paper’s primary inference—that companies shift tax bases across jurisdictions through allocations of income and expenses among commonly-controlled companies—is similar to ones drawn from extant studies, its superior data enable a more powerful analysis of income shifting than has been previously possible. In addition, this paper is one of the first to identify the accounts through which income is shifted to avoid taxes.