Are declining effective tax rates indicative of tax avoidance? Insight from effective tax rate reconciliations

Katharine D. Drake, Russ Hamilton and Stephen J. Lusch

Journal of Accounting and Economics, 2020, vol. 70, issue 1

Abstract: Effective tax rates (ETRs) are often used to compare tax avoidance across firms and time. Using firms' detailed tax footnote data, we find that the effect of valuation allowances (VA) related to prior-period losses biases GAAP ETRs. This downward bias explains almost all of the downward trend in domestic firms' ETRs over the last 20 years. We also find that VAs explain cross-sectional differences in ETRs for both domestic and multinational firms. We show this bias extends to cash ETRs and the Henry and Sansing (2018) tax avoidance measure. We develop a methodology for substantially reducing the bias in both time-series and cross-sectional analyses of cash and GAAP ETRs. Overall, our results suggest firms’ loss histories and GAAP rules influence inferences from tax avoidance proxies.

Keywords: Tax avoidance; Effective tax rates; Domestic and multinational firms; Time trends (search for similar items in EconPapers)
JEL-codes: G38 H25 H26 H32 (search for similar items in EconPapers)
Date: 2020
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Citations: View citations in EconPapers (15)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:jaecon:v:70:y:2020:i:1:s0165410120300197

DOI: 10.1016/j.jacceco.2020.101317

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