From Accounting to Taxation: Can Cash Flows Information Predict Tax Revenues? Cross-Country Evidence

• In Event: Reporting, Transparency, and Information Exchange

Abstract

Welsch, Williams, and Mills (2024) document that aggregate earnings contain information to predict future tax revenues. In this study, we show that this earnings-future tax revenues association is unique to the United States. Using global data from 37 countries between 1995 and 2022, we demonstrate that cash flows provide valuable information for predicting next year's total tax, value-added tax, corporate income tax, and personal income tax revenues, while we cannot find a significant association between earnings and next year's tax revenues after controlling for year and country factors. We then test and show that accounting quality at the country level influences the accounting-future tax revenues association. First, the association between cash flows and upcoming tax revenues is weaker during the global economic downturns and the COVID-19 outbreak, as the financial reporting becomes opaquer during the stressed periods. Next, we show that the ability of cash flows to predict tax revenues is weaker in European Union countries, as most of these countries are bank-based with civil-law backgrounds, which negatively influence the coverage and the timeliness of accounting information to capture economic activities, the basis of taxation. Our findings confirm the importance of incorporating country characteristics in examining the association between aggregate accounting numbers and future tax revenues.

Author

• Indra Tumbelaka, Monash University