Sean Kemsley

We create a stylized model of firms’ earnings management and tax avoidance decisions when taxes are levied on taxable income, and then alternatively levied on book income. The predicted effect of an alternative book-based tax on earnings management depends on the relative importance of scrutiny costs and the tax rates involved. Next, we use a difference-in-differences test to estimate the effect of the Corporate Alternative Minimum Tax (CAMT) on earnings management.

Contrary to pre-passage concerns about increased downward earnings management, we find mixed evidence indicating unchanged or increased upwards earnings management by affected firms. Our model suggests that pre-passage concerns about downward earnings management underappreciated that (1) book-tax scrutiny already exerted indirect downward pressure on earnings management before CAMT, and/or (2) upwardly managed earnings might enjoy preferential tax rates after CAMT. Thus, this study provides a framework to evaluate tax policy that comingles financial accounting measures with traditional tax bases.

Keywords: CAMT, book-tax differences, tax avoidance, earnings management

Abnormal-earnings models aggregate retained earnings with contributed capital, treat reallocation as frictionless, and earnings as exogenous. Personal taxation breaks all three. Under the U.S. distribution ordering rule, contributed capital cannot be returned tax-free until all retained earnings have been distributed as taxable dividends. Usually read as burying contributed capital, the rule is what makes the mix matter: reaching that capital requires taxing every retained dollar in front, so equity composition governs divestiture and expected earnings.

Two further results are sharp. Optimal payout is discrete: divest below the after-tax hurdle, then stop or clear all retained earnings, so otherwise identical firms diverge. And firm value kinks at the threshold, bending convexly under threshold uncertainty, with a slope change equal to the distribution-tax rate, independent of return parameters. Residual income valuation survives; what fails is the sufficiency of aggregate book value, which conceals a priced state variable at the distribution margin.

Keywords: residual income valuation, equity composition, payout policy, capital allocation · JEL: M41, G12, G32, G35

Litigators, regulators and academics have long debated whether tax evasion savings qualify as unlawful proceeds for money laundering purposes. A common objection holds that tax evasion merely lets a bad actor keep money already on hand, rather than producing a new inflow of wealth. We test that objection by applying the substance-over-form principle together with the economic-substance and step-transaction doctrines.

We find that in substance, tax evasion savings do qualify as unlawful proceeds: a dollar of evasion savings is substantively equivalent to a dollar of unlawful tax refund proceeds. Courts that value substance can therefore embrace the treatment, and the FATF could recommend it explicitly.

We ask whether income tax evasion also constitutes money laundering under a strict application of the Financial Action Task Force (FATF) Recommendations, including cases where an offender evades tax on lawful income. We apply the FATF conditions to the facts of United States v. Walter Anderson, in which the government alleged an attempt to evade $200 million of tax on lawful income.

Anderson’s actions met all of the FATF’s conditions for money laundering, implying that tax evasion — even on lawful income — is a form of money laundering. We argue the FATF should formally recognize this and codify a single crime covering both offenses, which could simplify prosecution, eliminate overlapping statutes and reduce double jeopardy concerns.

The FATF designates tax evasion as a predicate offense for money laundering. We ask whether that designation is complete, or whether the connection between the two crimes is stronger. Applying the FATF definition of money laundering alongside accepted definitions of tax evasion and of a standard predicate offense, we identify the necessary conditions for each crime and use them to test opposing hypotheses about the nexus.

Tax evasion does not meet the conditions for a standard predicate offense, and treating it as one is problematic in practice. Instead, the predicate label together with the methods and objectives of tax evasion implies that all tax evasion constitutes money laundering: in a single process, evasion generates criminal tax savings and launders those proceeds by concealing their unlawful origin.