Effects Of Tax Rate Changes Research Articles

Anticipated Reductions in Tax Rates and Earning Management of Listed Companies: Evidence from China

The effects of tax rate changes on corporations’ earning management are not fully understood. As a transitional economy, China has listed companies with different ownership and special regulatory rules. We explore under the expectation of tax reduction whether there are differences in the way and degree of earnings management implemented by different types of companies. Our study shows that firms under the anticipation of tax reduction make use of earning management, including delaying sales, taking unusual income-decreasing discretionary accruals, and so on, which leads to lower income in higher tax rate period. We find that private enterprises have more attention to reduce earning in the higher tax rate period than state-owned enterprises (SOEs), indicating that the ownership has effect on the extent of earning management. Moreover, under the specific regulations in Chinese stock market, we find that for those listed companies with negative net profit in the previous year, the priority is how to reverse losses rather than tax saving.

Tax Strategy Disclosure: A Greenwashing Mandate

Firms are facing progressively more stringent tax disclosure requirements. In this paper, we examine whether increased qualitative tax transparency leads to intended outcomes using, as an exogenous shock, the 2016 UK reform that mandated the disclosure of a tax strategy for arms above a certain size threshold. We and that arms that have to publish a separate tax strategy report significantly increase their voluntary tax disclosure in the annual reports, but we show no widespread effect on tax avoidance, measured by changes in effective tax rates. We document two mechanisms through which mandating a tax strategy report affects overall tax disclosure. First, we and large changes in disclosure for arms facing high public scrutiny. Second, arms with higher quality of tax strategy reports increase the qualitative discussion of their tax affairs in their annual reports by larger amounts, while arms with lower quality reports show increases in tax avoidance. Our results demonstrate the diffculty of generating a standard that effectively incentivizes desirable behavior when the disclosure mandate is asking for purely qualitative information.

Executive Compensation, Individual-Level Tax Rates, and Insider Trading Profits

We consider insider trading profitability as a means for executives to shift the impact of changes in individual-level tax rates to shareholders. Consistent with predictions from an analytical model, we document a positive association between abnormal insider trading profitability and changes in income tax rates at the federal and state level. We estimate that the changes in insider trading profitability offset between 12% and 16% of the effect of tax rate changes on net compensation for an average executive. We predict and find that several factors moderate this relation. We conclude that executives pass a portion of the tax effects onto shareholders through insider trading profits.

Tax-savvy executives

We investigate why firms include individuals with significant professional tax experience on their senior management team and the consequences associated with the presence of these tax-savvy executives. We find that past performance, network connections, geographic location, and tax-rate level, relative to industry peers, are all significant determinants of having a tax-savvy executive on the senior management team. Using propensity-score matching, we find that effective tax rates decrease substantially after the addition of a tax-savvy executive to senior management and revert following the departure of such an executive. We connect the changes in effective tax rates to changes in the usage of foreign subsidiaries in low tax jurisdictions.

Tax Strategy Disclosure: A Greenwashing Mandate?

Firms are facing progressively more stringent tax disclosure requirements. In this paper, we examine whether increased qualitative tax transparency leads to intended outcomes using, as an exogenous shock, the 2016 UK reform that mandated the disclosure of a tax strategy for firms above a certain size threshold. We find that firms that have to publish a separate tax strategy report significantly increase their voluntary tax disclosure in the annual reports, but we show no widespread effect on tax avoidance, measured by changes in effective tax rates. We document two mechanisms through which mandating a tax strategy report affects overall tax disclosure. First, we find large changes in disclosure for firms facing high public scrutiny. Second, firms with higher quality of tax strategy reports increase the qualitative discussion of their tax affairs in their annual reports by larger amounts, while firms with lower quality reports show increases in tax avoidance. Our results demonstrate the difficulty of generating a standard that effectively incentivizes desirable behavior when the disclosure mandate is asking for purely qualitative information.

Tax Savvy Executives

We investigate why firms include individuals with significant professional tax experience on their senior management team and the consequences associated with the presence of these tax-savvy senior executives. We find that past performance, network connections, geographic location, and tax rate level relative to industry peers are all significant determinants in having a tax-savvy executive on the senior management team. Using propensity score matching, we find that effective tax rates decrease substantially after a tax-savvy executive is added to senior management and revert following the departure of a tax-savvy executive from senior management. We connect the changes in effective tax rates to changes in the usage of foreign subsidiaries in low tax jurisdictions.

Implicit Corporate Taxes and Income Shifting

ABSTRACT The effects of tax rate changes on corporate profitability are not fully understood. Implicit tax theory predicts a positive relation between country-level tax rates and firm-level pretax returns. Conversely, income shifting should make reported pretax returns inversely related to tax rates. Among single-country European firms, we find robust evidence of corporate implicit taxes following tax rate changes, concentrated in firms that rely less on intangible assets and firms in closed economies (non-EU countries). Among multinational firm affiliates, we find the effects of income shifting outweigh the effects of implicit taxes for firms with high intangibles and in countries with open borders. Our results imply income shifting estimated using only reported profits is less biased by implicit taxes in settings with open economies and firms with unique inputs or products. Our evidence also helps explain prior evidence of decreasing corporate implicit tax effects over time, particularly for multinationals.

The structure of state corporate taxation and its impact on state tax revenues and economic activity

This paper documents facts about the state corporate tax structure — tax rates, base rules, and credits — and investigates its consequences for state tax revenue and economic activity. We present three main findings. First, tax base rules and credits explain more of the variation in state corporate tax revenues than tax rates do. Second, although states typically do not offset tax rate changes with base and credit changes, the effects of tax rate changes on tax revenue and economic activity depend on the breadth of the base. Third, as states have narrowed their tax bases, the relationship between tax rates and tax revenues has diminished. Overall, changes in state tax bases have made the state corporate tax system more favorable for corporations and are reducing the extent to which tax rate increases raise corporate tax revenue.

1990년 이후 유효세율의 변화추세

1990년 이후 유효세율의 변화추세

Grants and marginal cost of public funding: Empirical evidence for local governments in Brazil

This paper documents empirical evidence on price-effect caused by lumpsum grants for local governments in Brazil between 2006 to 2010. Dahlby (2011) demonstrates theoretically that lump-sum grants can reduce the cost of public goods provision (price-effect), in addition to the traditional income effect. Our contributions are threefold. First we estimated semielasticity of the effects of tax rate changes on tax base (−0.016). Second, we calculate the MCF of the local tax imposed on the supply of services (ISS) for Brazilian municipalities (average of 0.04). Finally, we estimate the priceeffect estimation for ISS tax. Our results suggests that for the entire sample, that an increase in R$ 1.00 in per capita unconditional transfers reduces the local price effect (MCF) around 0.07%, but this result is not consistently estimated across all subsamples.

Tax reforms and the capital structure of banks

The paper studies the link between corporate income tax reforms and domestic bank entities' financing decisions. We use a dataset of corporate income tax (CIT) reforms and estimate the effect of tax rate changes on leverage, dividend policies and earnings management of banks using BankScope (Orbis) data. Our results suggest that taxation influences all three variables in the first three years after the reform. Leverage increases with the CIT rate. The reason is that the statutory CIT rate determines the value of the debt tax shield. A higher tax rate increases incentives to use debt finance when interest payments are deductible from the CIT base. Also, dividend pay-outs increase after an increase of CIT rates. This could indicate that banks actively manage their pay-out policies around tax reforms and adjust their capital structure with changes in dividends. Furthermore, banks increase loss loan reserves in anticipation of a tax rate cuts since losses become less valuable with lower CIT rates. In the context of the current regulatory reform in the financial sector which focuses strongly on improving equity ratios of banks, our results suggest that future tax policies should focus on eliminating the favorable treatment of debt in general and for banks in particular. The reason is that this distortion at least partly undermines the regulatory objectives of increasing (regulatory) capital.

Tax Reforms and the Capital Structure of Banks

The paper studies the link between corporate income tax reforms and domestic bank entities' financing decisions. We use a dataset of corporate income tax (CIT) reforms and estimate the effect of tax rate changes on leverage, dividend policies and earnings management of banks using BankScope (Orbis) data. Our results suggest that taxation influences all three variables in the first three years after the reform. Leverage increases with the CIT rate. The reason is that the statutory CIT rate determines the value of the debt tax shield. A higher tax rate increases incentives to use debt finance when interest payments are deductible from the CIT base. Also, dividend pay-outs increase after an increase of CIT rates. This could indicate that banks actively manage their pay-out policies around tax reforms and adjust their capital structure with changes in dividends. Furthermore, banks increase loss loan reserves in anticipation of a tax rate cuts since losses become less valuable with lower CIT rates. In the context of the current regulatory reform in the financial sector which focuses strongly on improving equity ratios of banks, our results suggest that future tax policies should focus on eliminating the favorable treatment of debt in general and for banks in particular. The reason is that this distortion at least partly undermines the regulatory objectives of increasing (regulatory) capital.

Summaries of Papers in This Issue

Summaries of Papers in This Issue

The effects of tax rate changes on tax bases and the marginal cost of public funds for Canadian provincial governments

The efficiency losses from taxation vary directly with the responsiveness of a government’s tax bases to tax-rate increases. We estimate the dynamic responses of tax bases to changes in tax rates using aggregate panel data from Canadian provinces over the period 1972 to 2006. Our preferred empirical results indicate that a one percentage point increase in corporate income, personal income, and sales tax rates is associated with a 3.67, 0.76, and 1.17 percent reduction in their respective tax bases in the short run. The corresponding long-run tax base semi-elasticity estimates are higher: −13.60, −3.63, and −3.18, respectively. We use the tax base elasticity estimates to calculate the marginal cost of public funds (MCF) for the provinces’ three major taxes. Our computations indicate that the corporate income had the highest MCF and that the sales tax had the lowest MCF in all provinces in 2006. The MCF for the personal income tax ranged from 1.44 in Alberta to 3.81 in Quebec. Our results imply that there would have been significant welfare gains in 2006 from reductions in provincial corporate income tax rates. Our computations also indicate that the equalization grant formula may reduce the perceived MCF of the provinces that receive these grants, and that increases in provincial corporate and personal income taxes can cause significant reductions in federal tax revenues.

Equilibrium conditions in corporate tax competition and Foreign Direct Investment flows

We consider a collection of countries which attempt to maximize their corporate tax revenue, the latter being viewed as a function of Foreign Direct Investment (FDI) inflow and the Effective Average Tax Rate (EATR) which each country sets for itself. Under a model that assumes a direct influence of tax differentials on the flow of FDI, each country's decisions are naturally ‘coupled’ to those of others, leading to a non-cooperative game in which countries–players compete for FDI inflows by sequentially altering their tax rates. Their decisions are made via a differential equation-based model used to predict the effect of tax rate changes on a player's share of FDI inflows. Our model, calibrated using empirical data from 12 OECD countries for the period 1982–2005, combines FDI inflow and tax-rate differentials to arrive at a “steady-state” FDI inflow share for each player, given its competitors' corporate tax rates. We explore the game's equilibrium, including the question of whether equilibrium necessarily implies a ‘race to bottom’, with low corporate tax rates for all players.

Recent Russian Debate on Moving from VAT to Sales Taxes and Its Global Implications

We discuss recent policy debate in Russia on moving from the present value added tax to a sales tax structure covering households, government and exports. We describe and document the debate, discussing in detail what the perceived Russian problems with the VAT are. We suggest that many of the difficulties reflect the multi staging in the credit-invoice mechanism in the VAT, rather than the VAT per se. We discuss the possible use of the subtraction and addition methods in the VAT as an alternative to the sales tax proposed. We also report estimates of possible changes in effective tax rates across sectors if the sales tax were enacted.

Effects of Tax Rate Changes on the Cost of Capital: The Case of Japanese Firms

The paper studies the effects that tax rate changes have on the cost of capital when firms follow target leverage ratios. We show that changes in individual income tax rates are neutral. The focus therefore is on the effects of changes in marginal corporate tax rates. These effects are computed for Japanese firms. Special emphasis is given to changes in statutory tax rates and provisions that allow firms to carry their losses forward.

Earnings Management Through Effective Tax Rates: The Effects of Tax Planning Investment and the Sarbanes-Oxley Act of 2002

Dhaliwal, Gleason, and Mills (DGM 2004) document that firms manage earnings through decreases in effective tax rates (ETRs) between the third and fourth quarters. We investigate how firms' investments in tax planning impact this association between ETR changes and earnings management incentives. We also study two additional questions related to this association. First, we examine the impact of firms' choices to purchase tax services from providers other than their auditors on their use of third-to-fourth-quarter ETR changes. Second, we explore whether the Sarbanes-Oxley Act of 2002 (SOX) altered firms' propensity to engage in earnings management using changes in ETRs. For firms that would miss consensus earnings forecasts in the absence of ETR changes, higher tax service fees paid to auditors are associated with greater reductions in ETRs between the third and fourth quarters. Among firms that do not purchase tax services from their auditors, companies that would miss their earnings forecasts absent ETR changes also experience greater third-to-fourth-quarter reductions in ETRs than companies that would otherwise meet or beat these estimates. We find no statistically significant impact of the passage of SOX on the relation between tax fees paid to auditors and third-to-fourth-quarter decreases in ETRs for firms that would miss their earnings targets without managing tax expense. However, for firms not purchasing tax services from their auditors, a negative association exists between third-to-fourth-quarter ETR changes and missing income goals absent ETR changes in the pre-SOX period, but our tests fail to detect this relation in the post-SOX period.

HOW TAXES AFFECT MARKET PRICE: THE "LONGS AND SHORTS" OF DISCOUNTING AND INFORMATION

In one-period competitive equilibrium with risk-neutral traders, no discounting of money, and perfect information, the actual value of the marginal tax rate on capital gains from either or asset positions has no direct impact on market price. This is because the government shares in a trader's net losses to the same extent that it shares in the same trader's net gains, with exactly offsetting effects on the trader's expected utility. However, similar results do not necessarily hold for markets in which (1) money is discounted, and/or (2) individual traders possess private information about the intrinsic value of the asset's price. In this article, we study the effects of tax-rate changes on asset price in several one-period markets with different assumptions regarding discounting and private information. To investigate the interactions of these two effects as they apply to taxes on long-term capital gains, we construct a multi-period Markov chain to capture the behavior of traders with long or short positions in a market with both discounting and (randomly injected) private information. This model shows that, in equilibrium, an increase in the marginal tax rate on long-term capital gains from either long or short positions tends to dampen market price, with a greater impact in the case of capital gains from short positions.

Is the Effective Tax Rate an Effective Performance Measure?

This paper examines the properties of the effective tax rate (ETR) as a measure of managerial tax planning effectiveness using a principal-agent model. ETR is calculated as Tax Expense (computed pursuant to SFAS No. 109) divided by Income Before Taxes. The changes in ETR due to the agent's actions are systematically different from the changes in the principal's tax burden. These differences suggest that ETR is an ineffective measure of the agent's performance.