Understanding the Information Content of Book-Tax Differences

• In Event: Taxation

Abstract

We contribute to the literature attempting to understand the specifics of the information content of book-tax differences. We begin by developing a theoretical model that incorporates a report of taxable income in the Fischer and Verrecchia (2000) reporting bias framework. The key insight of our model is that book-tax differences are informative about growth in book income because there is uncorrelated measurement error in the accounting systems used to report income for tax purposes and for financial statements. The model suggests that large book-tax differences are particularly informative when there is greater noise in the measurement of book and/or taxable income. However, manipulation of earnings by managers reduces the information content of book-tax differences. We test our theory using methodologies found in the book-tax difference literature. Ultimately, we find evidence consistent with our theory. Namely, that book-tax differences are informative because they provide information regarding the potential inability of the accounting systems underlying book and taxable incomes to capture economic income.

Authors

• Terrence Blackburne, University of Pennsylvania

• Jennifer L. Blouin, University of Pennsylvania