Are Declining Effective Tax Rates Indicative of Tax Avoidance? Insight from Effective Tax Rate Reconciliations

Authors

Katharine D. Drake, University of Arizona - Department of AccountingFollow
Russ Hamilton, Southern Methodist University (SMU) - Accounting DepartmentFollow
Stephen J. Lusch, Texas Christian University - Department of AccountingFollow

Publication Date

3-23-2020

Abstract

Effective tax rates (ETRs) are often used to compare tax avoidance across firms and time. Using firms’ detailed tax footnote data, we find that the effect of valuation allowances (VA) related to prior-period losses biases GAAP ETRs. This downward bias explains almost all of the downward trend in domestic firms’ ETRs over the last 20 years. We also find that VAs explain cross-sectional differences in ETRs for both domestic and multinational firms. We show this bias extends to cash ETRs and the Henry and Sansing (2018) tax avoidance measure. We develop a methodology for substantially reducing the bias in both time-series and cross-sectional analyses of cash and GAAP ETRs. Overall, our results suggest firms’ loss histories and GAAP rules influence inferences from tax avoidance proxies.

Document Type

Article

Keywords

Tax Avoidance, Effective tax rates, Book-tax differences, Multinational firms

Disciplines

Accounting

DOI

10.2139/ssrn.2974219

Source

SMU Cox: Accounting (Topic)

Language

English