The Sources of Declining Effective Tax Rates: Insight From Effective Tax Rate Reconciliations
61 Pages Posted: 28 May 2017 Last revised: 10 Sep 2018
Date Written: September 4, 2018
Using firms’ tax rate reconciliations, we examine the sources of declining effective tax rates (ETRs) among profitable firm-year observations. We find the downward trend in domestic firms’ ETRs is largely attributable to the effects of decreases to the valuation allowance (VA) account. Our results indicate that failure to consider a firm’s loss history biases GAAP ETRs downward, since most VA decreases occur in profitable years but increases in VA occur in loss years, which are generally excluded from tax studies. To address this bias, we introduce a methodology for estimating the probability of VA release. Additionally, we find that the decline in multinational firms’ GAAP ETRs arises from declining foreign tax rates and decreasing amounts of income subject to state taxes. Our study provides new insight into the relative burdens of taxation across groups of firms, and how those burdens have changed over time.
Keywords: Effective tax rates, Book-tax differences, Multinational firms
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