Extreme ETRs: When Effective Tax Rates Capture Something Other than Tax Avoidance

Abstract

Many studies use the GAAP effective tax rate (ETR) as a proxy for tax avoidance. A maintained assumption of these studies is that GAAP ETRs are decreasing in corporate tax avoidance with very low ETRs indicating too much tax avoidance and very high ETRs indicating too little tax avoidance. Researchers are increasingly interested in the tails of the ETR distribution and the negative consequences of too little or too much tax avoidance. Our contribution is providing large-sample empirical evidence of what drives GAAP ETRs throughout the distribution – particularly in the tails. Using a sample of roughly 7,000 income tax footnote disclosures from 2008 through 2016, we document that factors largely unrelated to tax avoidance explain most of the deviation in GAAP ETRs from the statutory tax rate for observations in the top and bottom decile of the GAAP ETR distribution. For example, factors associated with firm performance represent 48 percent of the deviation in the lowest decile and 22 percent in the highest decile. Our findings inform researchers about factors unrelated to tax avoidance that drive significant deviations in GAAP ETR from the statutory tax rate.

Keywords: corporate tax, tax avoidance, accounting for income taxes, effective tax rate

JEL Classification: H25, H26, M41, M48