The effects of management practices on effective tax rates: evidence from Ecuador

This paper examines the effects of management practices on effective tax rates (ETR) in a sample of medium- and large-size manufacturing firms in Ecuador. By combining a novel data set on management practice scores with administrative records from tax fillings, we exploit the variation in management scores and firms’ characteristics within a regression analysis. Our results show that better management practices are positively associated with effective tax rates, defined as the share of tax obligations to profits. This result is robust under various specifications controlling for different covariates, and to different measures of effective tax rates. On one hand, this positive relationship is driven by two of the components of management practices: operations (a firm’s capacity to optimize its production process) and personal (a firm’s ability to attract and maintain high skills workers). On the other hand, firms with better management practices, on average, incur in higher nondeductible expenses, which greatly outweighs other avenues to reduce ETR, i.e., the use of fiscal incentives and redistribution of profit to workers. Overall, our findings suggest that government-sponsored policies that seek to promote better management practices may be self-sustaining if the expected additional tax revenue as a result of firms’ realizing higher profits is able to cover the cost of the programs.