Earnings Management around the Tax Cuts and Jobs Act of 2017

54 Pages Posted: 27 Jan 2021 Last revised: 31 Aug 2023

See all articles by Dan Lynch

Dan Lynch

University of Wisconsin-Madison - Department of Accounting and Information Systems

Max Pflitsch

Technical University of Dortmund

Michael W. Stich

Technische Universität München (TUM)

Date Written: August 31, 2023

Abstract

This paper examines earnings management around the reduction in the corporate tax rate from 35% to 21% as enacted by the Tax Cuts and Jobs Act (TCJA) of 2017. Building on a theoretical model that considers a higher level of book-tax conformity of ‘real activities manipulation’ (RAM) relative to ‘accrual-based earnings management’ (AEM), we hypothesize that firms concertedly use these techniques for different purposes. Specifically, we predict and find that firms engage in RAM to reduce taxable income in the high-tax period prior to the TCJA. Applying different estimation approaches, our results suggest that the 729 firms of our sample save between $14.1 billion and $15.8 billion in taxes by shifting taxable income from the high-tax to the low-tax period. We also predict and find that firms use AEM, which has lower book-tax conformity than RAM, to simultaneously increase book income in the high-tax period. Finally, we document negative future economic consequences of firms engaging in the most RAM activity. Overall, our results document an economically significant effect of the TCJA on firm behavior that should be of interest to policymakers, regulators, and researchers as they examine the economic effects of the largest tax reform in decades.

Keywords: Tax Cuts and Jobs Act (TCJA), tax reform, income shifting, tax avoidance, real earnings management, accrual-based earnings management.

JEL Classification: G12, G14, H25, M41, M48.

Suggested Citation

Lynch, Dan and Pflitsch, Max and Stich, Michael W., Earnings Management around the Tax Cuts and Jobs Act of 2017 (August 31, 2023). Available at SSRN: https://ssrn.com/abstract=3721848 or http://dx.doi.org/10.2139/ssrn.3721848

Dan Lynch (Contact Author)

University of Wisconsin-Madison - Department of Accounting and Information Systems ( email )

School of Business
975 University Avenue
Madison, WI 53706
United States

Max Pflitsch

Technical University of Dortmund ( email )

Emil-Figge-Straße 50
Dortmund, 44227
Germany

Michael W. Stich

Technische Universität München (TUM) ( email )

Arcisstrasse 21
Munich, DE 80333
Germany

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