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

56 Pages Posted: 28 May 2017 Last revised: 9 May 2019

See all articles by Katharine D. Drake

Katharine D. Drake

University of Arizona - Department of Accounting

Russ Hamilton

Southern Methodist University (SMU)

Stephen J. Lusch

Texas Christian University - Department of Accounting

Date Written: May 6, 2019

Abstract

Researchers, policymakers, and the media often use effective tax rates (ETRs) to compare tax burdens across firms and time, relying on the assumption that low ETRs reflect firms’ intentional actions to reduce taxes. Using firms’ detailed tax footnote data, we examine GAAP ETRs over time and find that nearly all of the downward trend in domestic firms’ ETRs is explained by the effect of valuation allowances (VA) related to prior-period losses, rather than deliberate tax planning. Among multinational firms, the decline in ETRs results from both declining foreign tax rates and decreasing percentages of income subject to state taxes. Additionally, because VAs are associated with firm loss history and tax loss carryforward usage, our results also offer an explanation for time-series and cross-sectional variation in cash ETRs. Overall, our results suggest firms’ loss histories and GAAP rules influence inferences from tax avoidance proxies.

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

Suggested Citation

Drake, Katharine D. and Hamilton, Russ and Lusch, Stephen J., Are Declining Effective Tax Rates Indicative of Tax Avoidance? Insight from Effective Tax Rate Reconciliations (May 6, 2019). Available at SSRN: https://ssrn.com/abstract=2974219 or http://dx.doi.org/10.2139/ssrn.2974219

Katharine D. Drake (Contact Author)

University of Arizona - Department of Accounting ( email )

Tucson, AZ 85721
United States

Russ Hamilton

Southern Methodist University (SMU) ( email )

6212 Bishop Blvd.
Dallas, TX 75275
United States

Stephen J. Lusch

Texas Christian University - Department of Accounting ( email )

M.J. Neeley School of Business
TCU Box 298530
Fort Worth, TX 76129
United States

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