The Effect of Political Sensitivity and Bargaining Power on Taxes: Evidence from Federal Contractors

Abstract

We investigate whether politically-sensitive contractors pay higher taxes and whether their bargaining power reduces these tax costs. Using federal contractor data, we develop a new composite measure of political sensitivity that captures both the political visibility arising from federal contracts and the importance of federal contracts to the firm. Our primary proxies for bargaining power are based on the ratio of contract revenues not subject to competition to total contract revenues, the ratio of defense contract revenues to total contract revenues, and industry concentration ratios. We find that politically-sensitive firms pay higher federal taxes, all else equal. However, firms with greater bargaining power incur fewer tax-related political costs. Our study provides new evidence of the political cost hypothesis in a tax setting and the first evidence of the interactive effects of a firm’s political sensitivity and bargaining power on tax-related political costs.