An Application of the Scholes and Wolfson Model to Examine the Relation between Implicit and Explicit Taxes and Firm Market Structure: An Analysis

Abstract

Callihan and White (1999) present a methodology for applying Scholes and Wolfson's (1992) model of implicit tax rates to financial statement data. This methodology is aimed at addressing two issues: (1) measurement of implicit tax rates and (2) determination of the extent to which firms possessing market power can shift implicit tax burdens away from the firm. This paper examines Callihan and White's empirically-driven definition of implicit tax rates and points to the pitfalls of using this definition for firms that may possess market power. In particular, I show that, since the Callihan and White measure assumes that firms do in fact operate in perfectly competitive markets, it cannot validly be used to measure the magnitude of implicit taxes in the presence of firm market power. Additionally, my analysis casts doubt over the validity of Callihan and White's finding that implicit taxes are lower for firms possessing market power.

JEL Classification: H25, H22, H23