Private equity and local public finances
Are tax authorities missing out on tax revenues due to restructurings and tax savings strategies of private equity investors? Research finds that PE buyouts are negatively associated with local governments’ tax revenues and spending.
The challenge:
The economic impact of private-equity investments on local-government finances is crucial because sound fiscal budgets and local-government spending are critical to economic development and community wellbeing. As of 2022, PE was the largest alternative asset class, with over $4.5 trillion in assets under management (projected to exceed $11 trillion by 2026). Their critical role begs the question how PE firms create value for the broader set of stakeholders beyond PE investors; particularly in relation to the PE industry’s contribution to tax revenues.
Are tax authorities missing out on tax revenues due to restructurings and tax savings strategies of private equity investors? Research finds that PE buyouts are negatively associated with local governments’ tax revenues and spending.
The challenge:
The economic impact of private-equity investments on local-government finances is crucial because sound fiscal budgets and local-government spending are critical to economic development and community wellbeing. As of 2022, PE was the largest alternative asset class, with over $4.5 trillion in assets under management (projected to exceed $11 trillion by 2026). Their critical role begs the question how PE firms create value for the broader set of stakeholders beyond PE investors; particularly in relation to the PE industry’s contribution to tax revenues.
The intervention:
To assess whether lower tax revenues have a wider impact on a government’s public finances through the effect on the available budget, we investigated public spending and debt financing after PE firms buyout companies in the jurisdictions of local governments. We examined over 11,000 deals and data relating to private firms in Europe and showed that target firms’ effective tax rates and total tax expenses decreased by 15% and 13% respectively after PE deals. At the same time, target firms expanded their capital expenditures and firm boundaries, but did not increase employment. Using administrative data on the public finances of German municipalities, we observed that PE buyouts are negatively associated with local governments’ tax revenues and spending; a result likely driven by reduced tax payments of PE firms’ portfolio companies, accompanied by only modest positive spillovers of PE investments on regional economic growth.
The impact:
The study provides novel evidence on the relationship between PE and local governments; showing that some PE firms create value for their shareholders by cutting tax expenses and that this harms the budgets of local governments. The finding of significant and persistent increases in firms’ tax efficiency after PE buyouts suggests that local governments could miss out on tax revenue. However, the study also shows that companies grow significantly, locally, in a country, and internationally after they get acquired by PE firms. Thus, the findings point the way for future research to pin down the mechanisms through which PE activity affects aggregate economic outcomes and better understand the contribution of PE to tax revenues at the country or global level.
