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The Optimal Relationship Between Taxable Income and Financial Accounting Income: Analysis and a Proposal

Daniel Shaviro

New York University School of Law

February 2008

NYU Law and Economics Research Paper No. 07-38
Georgetown Law Journal, Vol. 97

The persistence of the book-tax gap, or excess of companies' reported financial accounting income over their taxable income, suggests that accounting manipulation and tax sheltering remain significant problems, even in the aftermath of the "Enron era." Some have therefore suggested making the United States a "one-book" country, in which the same income measure would be used for both purposes. This Article offers the first systematic exploration of the optimal relationship between the two income measures, based on the distinct purposes they serve and the significance of two distinct sets of incentive problems: those pertaining to corporate managers, and to the political decisionmakers who make the rules.

Absent these incentive problems, the two ideal measures would differ, reflecting that allocating tax burdens is not the same exercise as informing investors. The incentive problems cut in favor of uniformity, however, by supporting the creation of a "Madisonian" offset between managers' and politicians' twin quests for high accounting income and low taxable income. But this offset has more promise as a device to constrain managers than politicians, given the difficulty of binding Congress and the existing partial insulation of accounting rules from direct political influence. In light of the political incentive issues, pure one-book and two-book approaches may both be inferior to partial conformity, such as that which would result from generally requiring a 50 percent adjustment by large, publicly traded companies of taxable income towards financial accounting income.

Number of Pages in PDF File: 66

Keywords: tax policy, optimal taxation, financial accounting, tax-book gap, corporate governance, tax sheltering

JEL Classification: H20, H21, H25, H28, M40, M41, G30, G38

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Date posted: September 27, 2007 ; Last revised: April 4, 2008

Suggested Citation

Shaviro, Daniel, The Optimal Relationship Between Taxable Income and Financial Accounting Income: Analysis and a Proposal (February 2008). NYU Law and Economics Research Paper No. 07-38; Georgetown Law Journal, Vol. 97. Available at SSRN: https://ssrn.com/abstract=1017073 or http://dx.doi.org/10.2139/ssrn.1017073

Contact Information

Daniel Shaviro (Contact Author)
New York University School of Law ( email )
40 Washington Square South
Room 314-B
New York, NY 10012-1099
United States
212-998-6187 (Phone)
212-995-4341 (Fax)

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