Agenda of Presentation• Introduction• Determinants of ETRs and hypotheses• Research design• Results and analyses• Conclusions

Introduction• Corporate effective tax rates (ETRs) are often used by policy-

makers and interest groups as a tool to make inferences about corporate tax systems because they provide a convenient summary statistic of the cumulative effect of various tax incentive and corporate tax rate changes (Kern and Morris, 1992; Gupta and Newberry, 1997) .

• Evidence in the US has shown that:

ETRs vary across firms and over time, which suggested that the corporate tax system was inequitable and so was a major justification for tax reform (Shevlin and Porter, 1992).

however, there is a lack of research on ETRs and tax reform, especially in countries outside the US.

Introduction• A potential reason for the lack of research in this area

corporate tax reform is infrequent; hence the opportunity for undertaking such research is limited.

• The Ralph Review of Business Taxation represented a major event in corporate tax reform in Australia. The Ralph Review was given a mandate by the Australian Government

to broadly assess the adequacy of the country’s business income tax policy (Ralph, 1999).

The Ralph Review’s key proposals were accepted by the Australian Government, and they were codified in the Income Tax Assessment Act (1997), with application from the 1999-2000 tax year.

Introduction• Research Objectives:

Examines the determinants of the variability in corporate effective tax rates in Australia spanning the Ralph Review of Business Taxation reform.

The study investigate the impact of firm size, capital structure (leverage) and asset mix (capital intensity, inventory

intensity and R&D intensity) on ETRs covering the Ralph Review.

Formal tests of the impact of the tax reform on these associations and whether ETRs are associated with these characteristics

after the tax reform are also considered.

Introduction• Research Purposes:

– Adds to the sparse literature about ETRs and tax reform.– Provide some further insights into ETRs that should be useful to

policy-makers.

ETRs and firm size• Two competing views about the association between

ETRs and firm size:– The political cost theory, and– The political power theory.

ETRs and firm size• The political cost theory

The higher the visibility of larger and more prosperous firms causes the to become victims of greater regulatory actions by government & wealth transfers (Watts & Zimmerman, 1986)

Taxes are one part of the total political costs borne by firms.Larger firms have higher ETRs (Zimmerman, 1983)

• The political power theoryLarger firms have substantial resources available to them to

manipulate the political process in their favor, engage in tax-planning and organize their activities to achieve optimal tax savings (Siegfried, 1972)

Larger firms have lower ETRs.

ETRs and firm size• Studies of US firms

The association between ETRs and firm size have produced conflicting results

Researcher Results

Zimmerman (1983) Positive association

Porcano (1986) Negative association

Gupta and Newberry (1997) Assert that the inconsistent results suggest that firm-size effects could be sample-specific and not likely to exist over time in firms with longer histories

ETRs and firm size• Studies of Australian firms

– Tran (1997) observes a negative association between ETRs and firm size.

– Tran (1998) finds that larger firms benefited more from tax-planning (tax incentives) than smaller firms.

Therefore this study expect a negative association between ETRs and firm size.

ETRs and firms’ financing

• Gupta and Newberry (1997)Firms’ financing decision could impact on ETRs because tax statutes normally allow differential tax treatment to the capital structure decisions of firms.

• Interest expenditure is tax deductible while dividends are not firms with higher leverage are expected to have lower ETRs.

• Stickney and McGee (1982) and Gupta and Newberry (1997) finds a negative association between ETRs and leverage.

ETRs and firms’ investment decisions• Tax statutes usually permit taxpayers to write-off the cost of

depreciable assets over periods shorter than their economic lives Firms that are more capital-intensive are expected to have lower ETRs

(Stickney and McGee, 1982)

• Inventory intensity is a substitute for capital intensity Inventory-intensive firms should possess higher ETRs (Zimmerman,

1983)

• R&D expenditure furnishes an investment tax shield for R&D-intensive firms. R&D-intensive firms are expected to have a negative association with

ETRs (Gupta and Newberry, 1997)

Hypotheses from previous discussion

H1: ETRs are negatively associated with firm size

H2: ETRs are negatively associated with firm leverage

H3: ETRs are negatively associated with firm capital intensity

H4: ETRs are positively associated with firm inventory intensity

H5: ETRs are negatively associated with firm R&D Intensity

ETRs and tax reform

• This study also investigate whether the Ralph Review tax reform had an effect on ETRs, and if it impacted on the associations between ETRs and variables reflecting the outcomes of firms’ financing and investment decisions.

• Table 1 shows:– The key Ralph Review tax-reform proposals– Estimation of corporate tax revenue impacts over the period

1999-2005.

ETRs and tax reform

The tax reform is expected to have a significant negative association with ETRs

ETRs and tax reformVariables Ralph Review tax reform Impact

Firm leverage Reduction in corporate tax rates

Decreases the tax savings on interest increases ETRs (positively impacted)

Firm capital intensity

Removal of accelerated depreciation & reduction in corporate tax rates

Expected to increase ETRs

Firm inventory intensity

Removal of accelerated depreciation & reduction in corporate tax rates

Substitute for capital intensity expected to have lower ETRs

R&D expenditure

No change in tax policy Not expected to have an impact

Hypotheses from previous discussion

H6: ETRs are negatively associated with the Ralph Review tax reform

H7: The associations between ETRs and firm leverage is positively impacted upon by the Ralph Review tax reform

H8: The associations between ETRs and firm capital intensity is positively impacted upon by the Ralph Review tax reform

H9: The associations between ETRs and firm inventory intensity is negatively impacted upon by the Ralph Review tax reform

H10: The associations between ETRs and firm R&D expenditure is not impacted upon by the Ralph Review tax reform

Sample and Data

Dependent Variable• Dependent variable ETRs

• In conventional research, ETRs = tax liability / income

• The appropriate definitions of both the numerator and the denominator of this equation are open to debate (e.g. Shevlin and Porter, 1992; Wilkie and Limberg, 1993; Plesko, 2003)

Numerator of the equation

Porcano, 1986; Gupta and Newberry, 1997.

The income tax expense of firms and make no adjustment for deferred tax expense.

Stickney and McGee, 1982; Omer et al., 1993.

Adjustment to income tax expense by subtracting the deferred tax expense portion.

This study uses income tax expense without any deferred tax adjustment as numerator because Australian firms are not required to report deferred tax expense in their financial statements under Accounting Standard AASB 1020: Accounting for Income Tax (Tax-Effect Accounting)

Dependent Variable

Denominator of the equation

Taxable income Should not be used if the purpose of a study is to capture the impact of tax incentives on ETRs.

Gupta and Newberry, 1997 If both the numerator (income tax expense) and the denominator (income) are after tax incentives, then any systematic variation in ETRs because of tax incentives will not be detected

Book income Used as the primary income measure

Cash flow from operations

Used as an alternative measure, as the controls for systematic differences in accounting method choices that are related to firm size (Zimmerman, 1983)

Dependent Variable

ETR1 =

ETR2 =

Income tax expenseBook income

Income tax expenseOperating cash flows

Independent Variables

Firm-specific variables

Firm size (SIZE) : the natural logarithm of total assets (at book value)

Financial leverage (LEV) : long-term debt / total assets (both at book values)

Capital intensity (CINT) : net PPE / total assets (both at book values)

Inventory intensity (INVINT) : inventory / total assets (both at book values)

R&D intensity (RDINT) : R&D expenditure divided by net sales.

Independent VariablesControl variables

Variable Purposes Measurement Predicted Sign

Return on Assets (ROA)

To control for changes in firms’ operating results

Pre-tax income / total assets

Positive Increase in ROA leads to an increase in ETRs (Gupta and Newberry, 1997)

Industry-sector (INSEC)

To avoid possibility for ETRs to fluctuate across different industry sectors (Omer et al., 1993; Mclntyre and Nguyen, 2000; Derashid and Zhang, 2003)

Nine INSEC dummy variables: energy, materials, industries, consumer discretionary, consumer staples, health care, information technology, telecommunications and utilities.

No sign predictions

Independent Variables

Tax reform variables

Ralph Review’s impact on ETRs, a period dummy variable (TREF) :

1 = observation is for the post-tax-reform period

0 = otherwise

Regression model

Descriptive statistics

Regression results

The results are consistent with all

hypotheses (except for H8).

Regression results

-The results indicate that SIZE, LEV, CINT, INVINT and RDINT are significantly associated with ETRs (ETR1 or ETR2 at p<.10 or better) after the tax reform.- ETRs continue to be associated with firm size, capital structure and asset mix after the tax reform.

Regression results

Robustness checksa. The study re-estimated its regression models by dividing its

sample into the pre-(1997-1999) and post-(2001-2003) Ralph Review tax-reform periods to determine whether the association in Table 4 between ETRs and SIZE, LEV, CINT, INVINT and RDINT remain intact

the results show that the coefficient for those variables had identical signs and similar levels of statistical significance in the pre- and post-tax-reform periods.

Robustness checksb. 1. variance inflation factors (VIFs) were computed for each independent

variable in our regression models

the VIFs indicate that multicollinearity is not problematic in any of the models.

2. to deal with potential outlier problems, the study re-estimated its regression models after excluding several outliers, based on the method suggested by Neter et al. (1996).

the result shows that in terms of sign and statistical significance are comparable to those reported in Table 4

3. re-estimated the regression models to include NOL carry-forward firms.

the results show that the coefficient estimates had similar signs, but weaker levels of statistical significance, as expected (see, e.g. Wang, 1991).

ConclusionsThis study find:

(a) A significant negative association between ETRs and firm size.

(b) ETRs have a significant negative association with capital structure for leverage.

(c) A significant negative (positive) association is also found between ETRs and asset mix for capital intensity and R&D intensity (inventory intensity).

(d) While the Ralph Review impacted on many of these associations, ETRs continue to be associated with firm size, capital structure and asset mix after the tax reform.

Research Contribution• This study adds to the scarce literature on ETRs and

tax reform.

• The results of this study provide some additional insights into ETRs that should be useful to policy-makers.

Research Limitation1. The sample is drawn from publicly-listed Australian firms.

Because of data unavailability, unlisted firms are excluded from the sample.

2. The study constructed its ETR measures using financial statement data since tax return data are private and unavailable.

The literature (see, e.g. Plesko, 2003) questions the accuracy of financial-statement-based ETR measures, so our results should be interpreted with some caution.

3. Its ETR model may be incomplete. It excluded the extent of firms’ foreign operations and ownership

structure, these variables might have an impact on ETRs.