Estimating Corporate Tax Avoidance with Accounting Data

Tax Notes, Vol. 162, No. 8, 2019

12 Pages Posted: 14 Apr 2019 Last revised: 22 Jul 2022

See all articles by Noel Brock

Noel Brock

Eastern Michigan Univeristy

Roy Clemons

New Mexico State University

Adam Nowak

West Virginia University

Date Written: February 25, 2019

Abstract

Motivation — Dyreng, Hanlon, Maydew, and Thornock (2017) find that US domestic corporations achieve greater levels of tax avoidance than their multinational counterparts (MNEs). Motivated by recent research, this study examines if the authors’ unexpected findings are associated with the research design choices used when the cash effective tax rate (Cash ETR) estimates corporate tax avoidance.

Objectives — The objectives of this study are to develop and test an alternative corporate tax avoidance measure that is not subject to the problematic research design choices that exist when estimating the Cash ETR. Specifically, we investigate alternatives to the researcher-selected cutoffs, the methods used to control for influential observations, and the discarding of loss years.

Methods — Building on the linear corporate tax function used by Edwards, Kubata, and Shevlin (2018) this study develops an alternative corporate tax avoidance measure. The tax avoidance measure developed in this study is the marginal propensity to tax (MPT) which represents the incremental tax payment in the current period due to an additional dollar of current period pretax income.

Results — When testing the MPT measure on the Dyreng et al. (2017) dataset, this study finds that MNEs engage in significantly more tax avoidance than domestic corporations. Specifically, the findings indicate that the MPT for MNEs is 3 percentage points lower than domestic corporations (26 percent and 29 percent, respectively). The results suggest that the unexpected results reported by Dyreng et al. (2017) reflect the undue influence of a few observations combined with the ordinary least squares (OLS) estimation procedure. To our knowledge, this is the first study to provide empirical evidence to suggest that the treatment of influential observations is an important factor to consider when estimating corporate tax avoidance.

Contribution — The MPT measure provides an empirically viable corporate tax avoidance estimator that offers several distinct advantages. The MPT 1) provides an easily interpretable measure of corporate tax avoidance that is meaningful for all firm year observations, 2) controls for changes in pretax income by using a linear corporate tax function, 3) utilizes robust regression to control for influential observations — eliminating the need for a priori choices by researchers, and 4) uses piecewise linear regression to accommodate the inclusion of loss years — after documenting the nonlinearity that exists when including loss years in the sample. Additionally, using the MPT measure, this study provides an alternative explanation for Dyreng et al.’s (2017) unexpected finding that US domestic corporations achieve greater levels of tax avoidance than MNEs.

Keywords: Effective tax rate; corporate tax function; multinational enterprises; influential observations

JEL Classification: G39, H20, H25, H32, H26, M41, M48

Suggested Citation

Brock, Noel and Clemons, Roy and Nowak, Adam, Estimating Corporate Tax Avoidance with Accounting Data (February 25, 2019). Tax Notes, Vol. 162, No. 8, 2019, Available at SSRN: https://ssrn.com/abstract=3344613

Noel Brock

Eastern Michigan Univeristy ( email )

Eastern Michigan University
Ypsilanti, MI 48197
United States
619-300-1207 (Phone)

HOME PAGE: http://https://www.emich.edu/cob/faculty/n_brock.php

Roy Clemons (Contact Author)

New Mexico State University ( email )

P.O. Box 30001
Las Cruces, NM 88003-8001
United States

Adam Nowak

West Virginia University ( email )

PO Box 6025
Morgantown, WV 26506
United States

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