Are declining effective tax rates indicative of tax avoidance? Insight from effective tax rate reconciliations

Katharine D. Drake, Russ Hamilton, Stephen J. Lusch

Research output: Contribution to journalArticle

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.

Original languageEnglish (US)
Article number101317
JournalJournal of Accounting and Economics
DOIs
StateAccepted/In press - Jan 1 2020

Keywords

  • Domestic and multinational firms
  • Effective tax rates
  • Tax avoidance
  • Time trends

ASJC Scopus subject areas

  • Accounting
  • Finance
  • Economics and Econometrics

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