Effects Of Tax Rate Changes Research Articles

Evidence of Differing Market Responses to Meeting or Beating Targets Through Tax Expense Management

Does using earnings management to meet or beat analysts' forecasts decrease the market reward to achieving this target? We use changes in effective tax rates from the third to the fourth quarter to estimate managed earnings, following and extending Dhaliwal, Gleason and Mills (2004). We demonstrate that the market discounts the reward to meeting or beating forecasts by an economically significant amount when the company achieves the target through earnings management, using a decrease in tax expense. Our findings are consistent with firms using earnings management to avoid the market punishment of missing the forecast, but failing to capture the full market reward for meeting the target without management. Our results are robust to including an estimate of abnormal accruals and suggest that identifying firms that manage tax expense contributes incrementally in understanding the market response to meeting or beating earnings.

The Persistence, Forecasting, and Valuation Implications of the Tax Change Component of Earnings

I examine whether earnings generated by changes in effective tax rates (the tax change component) persist and aid in forecasting future earnings. In addition, this study investigates to what extent investors incorporate the forecasting implications of the tax change component of earnings into stock prices. I find that there is a positive, significant association between the tax change component of earnings and future earnings. I use the interim reporting requirements of APB No. 28 (APB 1973) and FASB Interpretation No. 18 (FASB 1977) to further decompose the tax change component into an initial and a revised portion based on the first quarter estimate of the annual effective tax rates (ETR). I find that the initial tax change component is more persistent for future earnings than the revised tax change component. These results are consistent with my hypotheses that the initial and revised tax change components have differential persistence and forecasting implications, and dispute the broad notion advanced by prior literature that ETR-related earnings changes are transitory. Results from market tests indicate that the market underweights the forecasting implications of the tax change component and the mispricing appears to be driven by the transitory nature of the revised tax change component.

How Much Tax Do Large Public Corporations Pay?: Estimating the Effective Tax Rates of the S&P 500

Three recent phenomena - the corporate governance scandals, continuing concern about corporate tax shelters, and the Bush Administration's proposal to exempt dividends from income - have generated renewed interest in the amount of taxes paid by public corporations on the profits they report to their investors. This paper estimates the effective tax rates (ETRs) from 1995 to 2000 of the corporations included in the S&P 500 based on a comparison of their worldwide current income tax expense to their worldwide pre-tax book income. It finds that after controlling for the disparate tax and accounting treatment of stock options, the ETR of the sampled corporations declined slightly, from 30.11% in 1995 to 27.98% in 2000. Potentially more revealing is the fact that there is an important reduction in the 1999 ETR relative to the 1995-98 period (during which the ETR was virtually unchanged), and the 2000 ETR remains below the 1995-98 average. The paper is unable to relate these remaining changes in ETR to trends in foreign investment of the companies involved.The paper also estimates that the six-year ETRs (after stock option conformity) of ten industry groups varied from a low for the energy sector (25.72%) and industrials (25.84%) to a high for the information technology sector (32.48%) and utilities (32.43%). Both the level of taxation (compared to the statutory tax rate of 35 percent) and relative uniformity of tax treatment of the industries is to be contrasted with the much greater variations experienced by industries during the early 1980's.

How Much Tax Do Large Public Corporations Pay? Estimating the Effective Tax Rates of the S&P 500

Three recent phenomena - the corporate governance scandals, continuing concern about corporate tax shelters, and the Bush Administration's proposal to exempt dividends from income - have generated renewed interest in the amount of taxes paid by public corporations on the profits they report to their investors. This paper estimates the effective tax rates (ETRs) from 1995 to 2000 of the corporations included in the S&P 500 based on a comparison of their worldwide current income tax expense to their worldwide pre-tax book income. It finds that after controlling for the disparate tax and accounting treatment of stock options, the ETR of the sampled corporations declined slightly, from 30.11% in 1995 to 27.98% in 2000. Potentially more revealing is the fact that there is an important reduction in the 1999 ETR relative to the 1995-98 period (during which the ETR was virtually unchanged), and the 2000 ETR remains below the 1995-98 average. The paper is unable to relate these remaining changes in ETR to trends in foreign investment of the companies involved.The paper also estimates that the six-year ETRs (after stock option conformity) of ten industry groups varied from a low for the energy sector (25.72%) and industrials (25.84%) to a high for the information technology sector (32.48%) and utilities (32.43%). Both the level of taxation (compared to the statutory tax rate of 35 percent) and relative uniformity of tax treatment of the industries is to be contrasted with the much greater variations experienced by industries during the early 1980's.

The effects of tax rate changes on output and government deficits

In this paper, it is shown that changes in effective tax rates on capital income, labour income and consumption affect the incentives that individuals have to work and to accumulate capital, depending on the tax structure of each country. These incentive effects can induce large differences in the time paths of output and government deficits, thus (in)validating the dynamic Laffer curve proposition.

The Persistence, Forecasting Ability, and Valuation Implications of the Tax Change Component of Earnings

I examine whether and under what circumstances changes in net income caused by changes in effective tax rates (ETRs) (the tax change component) persist and whether the tax change component aids in forecasting future earnings incremental to aggregate earnings excluding the tax change. I decompose the tax change component of earnings into an initial and revised portion, which I hypothesize to have differential persistence and forecasting implications. Finally, I utilize the Mishkin (1983) procedure to determine if the market recognizes the forecasting implications of the differential persistence of the initial and revised tax change components. My results indicate that the tax change component is negatively associated with future tax changes. I find that the initial tax change component is more persistent for future tax changes than the revised tax change component. Additionally, I find that the initial tax change component is useful in forecasting future earnings, while the revised tax change component is not. These results are consistent with my hypotheses that the initial and revised tax change components have differential persistence and forecasting implications, and dispute the notion that changes in ETRs are transitory. Mishkin (1983) test results indicate that the market underestimates the persistence of the revised tax change component and the mispricing appears to be driven by firms in industries with above-average intra-year variation in the tax change component of earnings.

Tax rate changes and fiscal deficits: an empirical investigation

This paper shows that changes in effective tax rates on capital income, labour income and consumption affect the incentives that individuals have to work and to accumulate capital, depending on the tax structure of each country. These incentive effects can induce large differences in the time paths of output and government deficits, thus (in)validating the dynamic Laffer curve proposition.

Macroeconomic Profitability: Theory and Evidence

This paper gives an account of recent work on the measurement, statistical analysis, and theoretical analysis of macroeconomic profitability. Measurement issues include the treatment of holding gains on physical assets and net financial liabilities, national income accounting practices and recent revisions, and the use of accounting rates of return. Statistical work has focused on the identification of trends and shifts in profit rates not caused by cyclical fluctuations, and various theoretical explanations have been offered for the generally low rates of return that appeared in the 1970s. These include capital deepening stimulated by a reduction in the cost of capital funds; profit squeezes caused by some combination of slower productivity growth, real wage push, and raw material price inflation; declining capital productivity; and changes in effective tax rates.

State Tax Policy, Labor, and Tax Revenue Feedback Effects

A new computable general equilibrium model is used to predict the effects of tax rate changes on employment and other macrovariables in California. The model is dynamic in accounting for both migration and investment. The relative strength of migration, labor force participation, and investment in causing tax‐rate‐decrease‐induced growth is examined. The model is used to contrast expected effects of a tax rate increase with and without migration and investment.

The effect of the Economic Recovery Tax Act of 1981 and the Tax Reform Act of 1986 on the distribution of effective tax rates

In this study we analyse the effective tax rates of corporations from three periods: the years preceding ERTA (1978–1980), the years following ERTA (1982–1985), and the years following TRA86 (1988–1990). We examine differences in the level, distribution, and variation of effective tax rates during these periods and identify factors which explain the changes in effective tax rates over these periods. The evidence we present supports the view that ERTA resulted in a significant reduction in the level of corporate effective tax rates from the pre-ERTA period, with a high percentage of profitable firms avoiding significant explicit taxation. The most significant benefits from ERTA appear to have been enjoyed by large firms which made significant capital investments. Notwithstanding this finding, the evidence suggests that ERTA did not significantly exacerbate existing differences in tax rates among firms in different industries. Generally, the evidence suggests that TRA86 reversed the decline in tax rates brought about by ERTA. Effective tax rates increased significantly following TRA86 and fewer profitable firms were able to avoid significant explicit taxation. Firms which benefited inordinately during the post-ERTA period saw their tax rates rise following TRA86. Also, TRA86 appears to have reduced some of the variation in effective tax rates which existed among firms in different industries.

The Effects of Income Tax Rate Uncertainty in a Dynamic Setting

Most discussion of income tax policy focuses on the expected efficiency or equity gains that could result from alterations in income tax codes. Often overlooked is the uncertainty that is generated when taxpayers anticipate a change in the tax laws. For example, over the last decade the income tax codes in the U.S. have undergone three significant revisions and, while each of these revisions was accompanied by extensive debate concerning the effects of changes in particular statutory provisions, the uncertainty generated by such rapid changes in the tax codes received little attention. It is likely that the timing of these revisions as well as the revisions themselves were difficult to predict and, consequently, contributed to the uncertainty facing taxpayers. While income tax codes may be subject to a wide variety of changes, arguably the most consequential is a change in tax rates, given a fixed tax base. With a fixed tax base, changes in statutory tax rates translate into changes in effective tax rates. Because changes in effective rates have such a pervasive influence on decision making, it seems reasonable to expect that uncertainty regarding future effective tax rates may have serious consequences. We explore the impact of this particular form of tax code uncertainty on an individual's saving and portfolio decision making in a dynamic setting. Throughout our analysis the tax base is unchanging, so that we do not bother to distinguish between effective and statutory tax rates. In this setting we assume that the timing of tax rate changes is uncertain and that, if a change occurs, the new tax rate is unpredictable. We find that more (less) risk averse taxpayers will respond to an increase in the likelihood of a change in the tax code or an increase in the variability of future tax rates by increasing (decreasing) saving. We are also able to characterize those situations in which an increase in the likelihood of a change in the tax code or an increase in the variability of future tax rates will depress risk-taking. There is a growing literature that examines the effects of income tax uncertainty. For example, Auerbach and Poterba [3] and Bernheim [4] have dealt with uncertainty that alters a firm's taxable income, and, consequently, the effective tax rate faced by the firm. Auerbach and Hines [2] have analyzed corporate investment behavior in the U.S. by taking into account the possibility that investors anticipate future changes in tax laws. Models that examine the welfare consequences of uncertain tax rates have been developed by Weiss [9] in a static setting and by Bizer and Judd [5] in a dynamic setting. Estimates of the welfare costs associated with statutory tax uncertainty in

The Optimal Investment Strategy through Variable Universal Life Insurance

The Optimal Investment Strategy Through Variable Universal Life Insurance ABSTRACT Universal Life (UL) and variable universal life (VUL) insurance are among the most popular products in the life insurance industry. These policies provide variables rates of return depending on the investment performance of specific investment media, allow flexible premium payments and offer the traditional tax advantages of cash value life insurance. Using the basic economic concepts of marginal and averages rates of return, the authors of this paper provide a theoretical basis for determining the optimal premium contribution to UL or VL that maximizes the after-tax rate of return. The sensitivity of the optimal premium level to changes in the parameter values is also illustrated graphically. Introduction Universal life insurance (UL) and variable universal life insurance (VUL) were introduced in 1979 and 1984, respectively, to provide variable rates of return, flexible premium payments and the favorable tax treatment of cash value life insurance in an effort to help curb the flow of personal investment funds away from insurers. These policies comprised approximately 32 percent of total life insurance sold in 1987 [2]. This percentage is expected to rise as the result of the Tax Reform Act of 1986 (TRA), which adversely affected the tax treatment of many competing investment media. The cash value of UL policies typically earns a rate of return that tends to approximate money market rates and generally provides policyowners with a minimum guaranteed rate of return.(1) The VUL policyowner can select the investment medium from choices that frequently include money market funds, medium- or long-term bond funds and equity funds. The rates of return credited on the savings element of VUL policies are, thus, a function of market performance and there are no minimum guaranteed rates of return.(2) Within specified limits, the amount of premium paid on UL and VUL is at the discretion of the policyowner. The tax advantage of VUL is the same as for traditional cash value life insurance; therefore, VUL is a popular technique for deferring or avoiding income taxation on investment earnings.(3) VUL policies can be categorized into front-, back-, or no-load policies. Front-load policies have flat and/or proportional expense loadings that apply to every premium payment. They may also include a surrender charge. Back-load policies have no specific expense charges applicable to premium payments, but include surrender charges that gradually reduce the longer the policy is in force and may be eliminated after a certain holding period. No-load policies have neither proportional expense loadings nor surrender charges.(4) Insurers issuing no-load policies cover expenses and profits through the differential between credited and achieved interest rates and/or markups on the mortality charges. The relative tax advantage of VUL increases over time, so there is generally a minimum holding period before VUL dominates alternative investment strategies such as a buy-term-and-invest-the-difference approach.(5) Several studies have been performed on the tax advantages of life insurance products, including cash value life insurance and annuities. Adelman and Dorfman [1] compared tax-deferred annuities with other investment alternatives and measured the effect of tax rate changes on the investment results. Broverman [4] studied the internal rate of return on life insurance and annuities by examining contingent death benefits over premiums paid and illustrated that the holding period is a critical factor in determining investment performances. Warshawsky [13] conducted research on the effect of the 1982 Tax Equity and Fiscal Responsibility Act and the 1984 Tax Reform Act and found that the higher the interest rate, the better the life insurance performance over competing investment alternatives. …

Taxpayer compliance under uncertainty

The present study investigates taxpayers' economic incentives to comply under conditions of uncertainty induced by tax law complexity and audit outcome uncertainty. In particular, previous research is extended by modeling an environment in which taxpayers have uncertainty about their tax liability and by simultaneously considering different tax rate structures and risk-taking attitudes. The major theoretical finding is that greater tax liability uncertainty creates incentives for taxpayers to increase reported income under certain conditions, but to decrease reported income under other conditions. For ranges of parameter conditions that commonly occur in the United States, however, we show that, unless taxpayers are highly risk-averse, an increase in income uncertainty is much more likely to lead to a reduction in reported income. Taxpayers' incentives to obtain tax advisory services as a means of reducing uncertainty also are investigated and shown to depend upon the audit probability, the penalty rate, and the tax rate. We find that increasing the audit probability will not necessarily increase taxpayers' incentives to purchase advisory services. Another finding is that the effects of tax rate changes depend upon taxpayers' risk-taking attitudes and can either increase or have no effect upon reported income. Furthermore, we find that taxpayers' reporting decisions under a progressive rate structure are the same as under a proportionate rate structure. Several policy implications of our analysis for taxpayer compliance and experimental studies are identified.

Income tax evasion: An intersectoral analysis

This paper develops an intersectoral model of income tax evasion with general equilibrium effects. Key elements of the model are imperfectly substitutable outputs from the compliant and evading sectors and workers with heterogeneous evasion costs. The model allows for biased public expenditures, a wide range of behavioural responses, and both legitimate and criminal activities evading tax as well as tax-avoidance activities. Qualitative and quantitative assessments are undertaken for the effects of tax rate changes on evasion activity, relative output prices, and real tax revenues. This approach offers useful findings for taxation policy and is amenable to further analytical extensions.

Taxation of Interest Income, Deregulation and the Banking Industry

ABSTRACTRemoving interest rate ceilings on bank deposits or reducing the tax rate applicable to the interest earned on such deposits are alternative means of increasing the after‐tax return to depositors. These alternatives, however, have differing impacts on the structure of a competitive banking industry. This paper develops a model which focuses on a bank's choice between paying an explicit interest rate on its deposits and paying a return in the form of services. The model allows banks to differ in their production technologies and depositors in their marginal tax rates and preferences for services. The effects of tax rate changes and a ceiling on the explicit deposit interest rate are analyzed.