Identifying Different Types of Tax Avoidance: Implications for Empirical Research

We provide a theoretical framework to identify when measures of tax avoidance reflect tax avoidance related to, and unrelated to, earnings management. The influence of earnings management on measures of tax avoidance occurs because pretax financial accounting income is used as a benchmark against which tax payments are measured. A firm that manages earnings upward without paying additional tax on the managed earnings can be considered to have avoided tax. We demonstrate that a measure of tax avoidance that has been used in prior research—the ratio of cash taxes paid to pretax operating cash flows—captures tax avoidance that is unrelated to earnings management. Use of this alternate measure in empirical studies can avoid attributing earnings management results to tax avoidance. JEL Classifications: M41; H25; G12.