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Data Truncation Bias and the Mismeasurement of Corporate Tax Avoidance

48 Pages Posted: 24 Sep 2013 Last revised: 30 Sep 2014

Erin Henry

University of Tennessee, Knoxville

Richard C. Sansing

Tuck School of Business at Dartmouth

Date Written: September 29, 2014

Abstract

This study examines the use of the cash effective tax rate (Cash ETR) as a measure of corporate tax avoidance. The Cash ETR normalizes cash taxes paid by pre-tax book income. Empirical studies of the Cash ETR delete or winsorize many observations for which the measure is not meaningful. In addition, high pre-tax book income in the denominator biases the Cash ETR towards the statutory rate. We propose an alternative measure that is meaningful for all observations. Whereas Cash ETR studies suggest that the average corporation is tax-favored, our measure indicates that the opposite is true. In addition, our study suggests an explanation for inconsistencies in the extant literature regarding the relation between pre-tax profitability and tax avoidance. Our measure shows that that more profitable firms engage in greater levels of tax avoidance.

Keywords: Cash effective tax rate, truncation bias, tax avoidance, scaling

JEL Classification: H25, M41

Suggested Citation

Henry, Erin and Sansing, Richard C., Data Truncation Bias and the Mismeasurement of Corporate Tax Avoidance (September 29, 2014). 2014 American Taxation Association Midyear Meeting. Available at SSRN: https://ssrn.com/abstract=2329694 or http://dx.doi.org/10.2139/ssrn.2329694

Erin Henry

University of Tennessee, Knoxville ( email )

Knoxville, TN 37996
United States

Richard Sansing (Contact Author)

Tuck School of Business at Dartmouth ( email )

100 Tuck Hall
Hanover, NH 03755
United States
603-646-0392 (Phone)
603-646-1308 (Fax)

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