A number of empirical studies have used effective tax rate(ETR) measures calculated from financial statement information to examine the relations between taxes, firm decisions, and firm characteristics. Studies using the average effective tax rate to ...
A number of empirical studies have used effective tax rate(ETR) measures calculated from financial statement information to examine the relations between taxes, firm decisions, and firm characteristics. Studies using the average effective tax rate to measure corporate tax (dis) advantage have played a critical role in tax legislation. Recent research, however, has questioned the effectiveness of the ETR for this purpose.
Previous research on corporate ETRs identified three important findings : (1)ETRs vary across firms(industries), (2) ETRs change over time, and (3) variances of ETRs differ across industries. These findings were explained solely in terms of cross-sectional and intertemporal differences in tax preferences. All other factors were implicitly assumed to be unimportant.
This paper challenged the existing explanation by deriving the ETR as a function of the marginal tax rate and two variables : tax preferences and (pre-tax accounting)income. The model demonstrated how changes in the ETR can occur under two alternative assumptions about the relationship between tax preferences and income. Specifically, when tax preferences and income are perfectly correlated, the model showed that changes in the ETR are caused solely by changes in tax preferences. In the absence of perfect correlation, however, the model indicated that both tax preferences and income are capable of causing the ETR to change.