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

71 Pages Posted: 28 May 2017 Last revised: 24 Mar 2020

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: March 23, 2020

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.

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 (March 23, 2020). Journal of Accounting & Economics (JAE), Forthcoming. 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

Here is the Coronavirus
related research on SSRN

Paper statistics

Downloads
389
Abstract Views
2,002
rank
79,174
PlumX Metrics