An empirical analysis of the relationship between corporate effective tax rates and book effective tax rates with an analysis of the financial characteristics that influence corporate effective tax rates

Throughout the 1970's and 1980's Congress has used the tax code as a conduit for social and economic policy. By using the tax code in this manner, corporations engaged in certain industries or large corporations who have the resources to lobby Congress might have benefited through lower effective tax rates (ETR's). In examining these issues, a longitudinal approach is used to measure a corporation's ETR. A corporation's ETR is calculated using a weighted average approach over a 14-year period . Specifically, a corporation's ETR is calculated by summing its current tax liability (CTL) over the 14-year period and dividing by its aggregate net income (ANI) for the same period.

In conjunction with examining corporate ETR's, the study investigates whether deferred taxes, in the aggregate, reverse over time. The study investigates this question by comparing the difference between a corporation's effective tax rate (ETR) and its book effective tax rate (BETR). The difference between these two variables is referred to as a corporation's book tax difference (BTD). If deferred taxes reverse over time then BTD should equal zero. The study also examines whether BTD's are consistent across industry and firm size.

Data were collected from 1,095 firms on the COMPUSTAT 1987 tapes for the period 1973 to 1986. The data set represents the population of firms having all 14 years of data and SIC Codes between 1000 and 5999. To test whether industry or size had an impact on ETR or BTD seven measures of central tendency were employed. The seven measures were: an unweighted average, weighted average, unweighted trimmed mean, weighted trimmed mean, unweighted Winsorized mean, weighted Winsorized mean, and median.

The results of the study indicate that for all measures examined, except the weighted trimmed, ETR was not equal across industry. With the exception of the unweighted measure and the median, the size of the firm does not effect ETR. The study also found that deferred taxes, in the aggregate, do not reverse over time. The results also indicate that BTD's are not consistent across industry and that for the unweighted, weighted, and median measures of central tendency size has an impact on BTD's.

The study concludes that large firms and certain industries (e.g., SIC 4000-4999) have benefited more than other industries and small firms from the economic incentives provided in the tax code. The study found that from a financial accounting perspective, the comprehensive method of accounting for deferred income taxes has created a liability on the balance sheet that represents a permanent not temporary difference. Finally, the book Vll effective tax rate set forth in the footnotes to the financial statements does not provide useful cash-flow information to investors or creditors.