Abstract

While tax avoidance has been identified as the primary behavioral response to inheritance and gift taxation, relatively few is known about the potentially negative externalities of inheritance and gift tax avoidance on production, employment and output of firms being transferred from one generation to the next. In this paper, we study the effect of business gift tax avoidance on firm growth and employment in Germany. Since 2009, the German inheritance and gift tax law creates an incentive to downsize before a firm transfer. Generous tax exemptions are denied if firms do not maintain employment after the transfer. We estimate excess separations before ownership transfer of family firms to quantify the efficiency cost of inheritance and gift tax avoidance in Germany, where family firms represent the backbone of the economy. We find that affected firms manipulate employment to be less restricted by the legal requirements after the transfer. We confirm this finding across different identification strategies.