What Determines ETRs? The Relative Influence of Tax and Other Factors

Posted: 26 Jul 2021

See all articles by Casey M. Schwab

Casey M. Schwab

University of North Texas

Bridget Stomberg

Indiana University - Kelley School of Business

Junwei Xia

Texas A&M University - Department of Accounting

Multiple version iconThere are 2 versions of this paper

Date Written: July 19, 2021

Abstract

Many studies use GAAP effective tax rates (ETRs) as a proxy for tax avoidance and assume that very low (high) ETRs represent the greatest (least) tax avoidance, yet ETRs can be affected by items unrelated to tax avoidance. Despite awareness of the potential limitations of ETRs as a measure of tax avoidance, the literature lacks consistent evidence on the extent to which ETRs capture tax avoidance versus other factors. We take a step toward filling this void using income tax footnote disclosures from 2008 through 2016 to investigate how well ETRs capture cross-sectional differences in tax avoidance versus other factors. We document that ETRs below 5% and above 40% are significantly influenced by items largely unrelated to tax avoidance, such as valuation allowances and goodwill impairments. Truncating ETRs at zero and one, controlling for standard determinants of tax avoidance, and using industry-size-adjusted ETRs or multiyear GAAP ETRs do not eliminate the clustering of factors largely unrelated to tax avoidance in the tails of the ETR distribution. Cash ETRs attenuate but do not eliminate this clustering. Researchers can use ETR rate reconciliation data to construct an adjusted ETR that removes the influence of factors largely unrelated to tax avoidance. Our findings inform researchers about factors largely unrelated to tax avoidance that drive significant deviations in ETRs from the statutory tax rate. This 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 rate, valuation allowance, goodwill impairments, FIN 48

Suggested Citation

Schwab, Casey M. and Stomberg, Bridget and Xia, Junwei, What Determines ETRs? The Relative Influence of Tax and Other Factors (July 19, 2021). Contemporary Accounting Research, Forthcoming, Available at SSRN: https://ssrn.com/abstract=3891348

Casey M. Schwab (Contact Author)

University of North Texas ( email )

1155 Union Circle #305340
Denton, TX 76203
United States

Bridget Stomberg

Indiana University - Kelley School of Business ( email )

1309 East Tenth Street
Indianapolis, IN 47405-1701
United States

Junwei Xia

Texas A&M University - Department of Accounting ( email )

430 Wehner
College Station, TX 77843-4353
United States

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