The Smoothing and Informativeness of GAAP Effective Tax Rates

• In Event: Tax and Financial Reporting

Abstract

We examine the extent to which the smoothing of GAAP effective tax rates (ETRs) through tax accruals affects the ability of current-period GAAP ETRs to predict future cash ETRs. We develop a measure of GAAP ETR smoothing that isolates smoothing due to tax accruals from the fundamental smoothness of tax rates evident in the volatility of cash ETRs. Our results show that a one standard deviation increase in GAAP ETR smoothing is associated with a 26 to 29 percent increase in the ability of current-period GAAP ETRs to predict future cash ETRs. We find that managerial discretion enhances the informativeness of tax accrual smoothing, but not in the presence of alternative reporting incentives, such as meeting earnings targets or avoiding attention from tax authorities. Our findings add to the tax and financial reporting literatures by showing that smoothing through tax accruals enhances the informativeness of GAAP ETRs for future cash tax outcomes.

Authors

• Paul Demere, University of Illinois-Urbana-Champaign

• Yue Li, University of Illinois at Urbana-Champaign

• Petro Lisowsky, University of Illinois-Urbana-Champaign

• R. William Snyder, University of Illinois at Urbana-Champaign