Abstract This study investigates whether political scrutiny of corporate effective tax rates (defined as current federal tax expense divided by pre-tax book income) influences accounting policy choices. In an attempt to increase corporate taxes with the Tax Reform Act of 1986 (TRA 1986), political groups used effective tax rates to argue that many corporations paid little or no federal taxes. We propose that the political attention to effective tax rates influences firms with low effective tax rates to choose income-decreasing accruals with low book-tax conformity in order to increase reported effective tax rates. Higher effective rates suggest "equity" to tax policy makers and reduce the likelihood of higher future taxes. Accruals with low book-tax conformity increase deferred taxes and thus, our proxy for the change in low book-tax discretionary accruals is the change in deferred tax expense. We expect that firms with low average effective tax rates during 1981-1984 (prior to legislative deliberation) will decrease income and deferred tax expenses with low book-tax accruals in the financial reporting year prior to TRA 1986. Therefore, we predict a positive association between 1981-1954 average effective tax rates and changes in deferred tax expenses for 1985. Consistent with our prediction, we find a positive association for a sample of firms publicly identified by the Citizens for Tax Justice (1985) as "corporate freeloaders." This result suggests that political scrutiny of effective tax rates provides incentives that influence discretionary accounting choices.
Northcut et al. (Tue,) studied this question.