The Effect of Paid Preparer Competition on Individual Tax Avoidance

Abstract

This study considers how competition among paid preparers affects individual tax avoidance. Merging individual tax return data reported to the IRS at the county level with household income reported by the U.S Census Bureau, along with supply of paid preparer establishments from the National Employment Time Series (“NETS”) database, we observe that paid preparer competition is positively associated with underreporting of income, consistent with competition facilitating client appeasement for avoiding more taxes. Our results are robust to various proxies for paid preparer competition and tax avoidance. In additional analysis, we note that our findings are stronger in counties whose taxpayers more frequently engage a paid preparer and among establishments that do not purport to be a CPA firm. This study contributes to our understanding of how competition impacts financial intermediaries’ decision-making and the environmental factors affecting paid tax preparers’ recommendations.