Effective Tax Planning

Abstract

We use data envelopment analysis (DEA) to develop a measure of effective tax planning that is theoretically aligned with the Scholes-Wolfson paradigm and captures how efficiently firms maximize after-tax returns given their operating, investing, and financing decisions. We then (1) document the measure is associated with higher after-tax returns to provide assurance DEA achieves its objective in our setting, (2) demonstrate the measure is incremental to cash ETRs in predicting after-tax returns, (3) validate the measure by showing its association with lower tax and non-tax costs, and (4) provide evidence the measure captures something about taxes distinct from overall firm performance. This measure is useful to researchers given the known limitations of ETRs as a measure of tax planning.