Abstract
It is well known that the typical U.S. firm faces a convex tax schedule (Graham and Smith 1999). This paper analyzes the effective tax rate (ETR) for a firm facing a convex tax schedule, and shows how the degree of convexity affects the ETR. In addition to the traditional factors (earnings level, leverage ratio), it is shown that the ETR should also be affected by firm-specific characteristics such as earnings growth rate and earnings volatility via their impact on tax convexity. Earnings growth rate should have a positive effect, and earnings volatility a negative effect, on ETR. Empirical tests with a large sample of U.S. firms provide strong support for the predictions regarding the determinants of ETR.
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