The Decreasing Trend in Cash Effective Tax Rates

This paper explores the previously documented decreasing trend in ETRs (Dyreng et al. 2017), which has been interpreted as increased tax avoidance by U.S. firms. We assume a linear tax function, where taxes paid are regressed on pre-tax income. The intercept captures taxes paid effects that are independent of current income and the slope coefficient is the marginal propensity to tax (MPT). In the presence of an intercept in the tax function, average ETRs are economically related to the MPT if pre-tax income is positive and exhibits a growth trend. Thus, although firms may have stable linear tax functions, indicating no systematic changes in their tax avoidance behavior, a decrease in average ETRs may be observed over time simply because of growth in pre-tax income. Specifically, average ETRs will decline (increase) and converge towards the MPT when there is a positive (negative) intercept and growth in income. We document a stable linear tax function for U.S. firms over the past 25 years, in which (i) the intercept is positive and (ii) pre-tax income is growing. The main implication of our findings is that the wholesale concerns regarding increased tax avoidance over time, measured by ETRs, are potentially overstated.