What determines ETRs? The relative influence of tax and other factors

Abstract

Many studies use GAAP effective tax rates (ETR) as proxies for tax avoidance and rely on the maintained assumption that very low (high) ETRs represent the greatest (least) tax avoidance. We provide large-sample empirical evidence on how well ETRs capture cross-sectional differences in tax avoidance versus other factors. Using income tax footnote disclosures from 2008 through 2016, we document that items most related to firm performance explain a large portion of the deviation from the statutory tax rate for ETRs below 5% and above 40%. Cash ETRs and multi-year GAAP ETRs suffer similar limitations. Our findings inform researchers about factors not primarily related to tax avoidance that drive significant deviations in ETRs from the statutory tax rate. Understanding the drivers of ETRs is of increasing importance as the number of studies examining the consequences of very high and very low ETRs grows.

Keywords: tax avoidance, effective tax rates, firm performance

JEL Classification: H25, H26, M41, M48