Does diverse tax planning reduce tax risk?

We investigate the relationship between diverse tax planning and a firm’s level of tax risk. Prior studies have suggested that firms face a trade-off between engaging in tax avoidance and managing exposure to tax risk, defined as the volatility of future tax outcomes. We propose that firms may be able to achieve both objectives by diversifying their portfolios of tax avoidance strategies. We create two measures of diversification based on two different ways of measuring tax avoidance. Using these two measures, we find that tax strategy diversification benefits firms in two ways. First, when holding the level of tax avoidance constant, increasing diversification reduces the firm’s exposure to tax risk. Second, when firms increase their level of tax avoidance, having higher diversification mitigates the impact of the increased tax avoidance on their tax risk exposure. Our study highlights the benefits of firms engaging in a diverse portfolio of tax strategies and shows that the relationship between tax avoidance and tax risk is contingent on the firm’s diversification, which may provide an explanation for the mixed evidence found in prior literature.