The Smoothing and Informativeness of GAAP Effective Tax Rates

We examine the extent to which the smoothing of GAAP effective tax rates (ETRs) through tax accruals affects the ability of current-period GAAP ETRs to predict future cash ETRs. We develop a measure of GAAP ETR smoothing that isolates smoothing due to tax accruals from the fundamental smoothness of tax rates evident in the volatility of cash ETRs. Our results show that a one standard deviation increase in GAAP ETR smoothing is associated with a 37 percent increase in the ability of current-period GAAP ETRs to predict future cash ETRs. We find that managerial discretion plays an important role in the informativeness of tax accrual smoothing. While smoothing through discretionary tax accruals explains the average informativeness of smoothing, the informativeness decreases significantly in the presence of alternative reporting objectives such as maintaining perfectly smooth ETRs or avoiding audit attention from tax authorities. Our findings add to the tax reporting literature by showing the informational value of ETR smoothing through tax accruals, and the negative impact of alternative reporting objectives on the informativeness of ETR smoothing.