Fundamental Properties of Financial Accounting Measures of Corporate Income Tax Liabilities

Abstract

This paper examines two financial accounting measures of corporate income tax liabilities: the deferred tax liability and the average effective tax rate. It derives the appropriate way to discount the deferred tax liability for valuation purposes. It also shows that effective tax rates based on financial accounting data fail to detect tax- favored investments that do not generate temporary differences. A new measure based on stock market returns detects tax-favored investments, regardless of whether they generate book-tax differences. However, the market based measure contains a source of measurement error not found in accounting based measures

JEL Classification: G12, M41