Pain at the Pump: Excise Tax and Earnings Management

• In Event: Tax Planning and Litigation Risk

Abstract

This study investigates whether excise tax collecting firms manage earnings in response to the threat of political costs related to the excise tax. We exploit the political process regarding the increase of the federal fuel tax excise to financially sustain the U.S. Highway Trust Fund in 2005. Using oil firms’ quarterly data, this paper finds that, oil firms do not engage in income-decreasing accrual earnings management during quarters in which the Congress and the Senate discussed the fuel excise tax increase. In the same period, oil firms use real earnings management, inflating sales, boosting production and emptying inventories to increase the excise tax collected. The findings are corroborated by a battery of robustness tests, placebo tests and further investigations on alternative excise tax (i.e. tobacco and cigarettes producers). This paper contributes to prior literature, as it extends the political cost hypothesis in tax settings, by showing evidence that tax collecting firms incur political costs related to tax transaction with the government. Also, the study shows that orchestrating the appearance of lower profits is not the only way in which firm respond to political threats. To our knowledge, this is the first paper to provide a thorough examination and robust evidence of real earnings management in response to political threat. The paper has policy implications.

Authors

• Alessandro Paolo Rigamonti, University of Pisa

• Giulio Greco, University of Pisa

• Alessandro Capocchi, University Milano-Bicocca