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Bank-Tax Conformity for Corporate Income: An Introduction to the Issues

  • Michelle Hanlon
  • Terry Shevlin
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    This paper discusses the issues surrounding the proposals to conform financial accounting income and taxable income. The two incomes diverged in the late 1990s with financial accounting income becoming increasingly greater than taxable income through the year 2000. While the cause of this divergence is not known for certain, many suspect that it is the result of earnings management for financial accounting and/or the tax sheltering of corporate income. Our paper outlines the potential costs and benefits of one of the proposed "fixes" to the divergence: the conforming of the two incomes into one measure. We review relevant research that sheds light on the issues surrounding conformity both in the U.S. as well as evidence from other countries that have more closely aligned book and taxable incomes. The extant empirical literature reveals that it is unlikely that conforming the incomes will reduce the amount of tax sheltering by corporations and that having only one measure of income will result in a loss of information to the capital markets.

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    File URL: http://www.nber.org/papers/w11067.pdf
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    Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 11067.

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    Date of creation: Jan 2005
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    Handle: RePEc:nbr:nberwo:11067
    Note: PE
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    1. Boynton, Charles & Mills, Lillian, 2004. "The Evolving Schedule M–3: A New Era of Corporate Show and Tell?," National Tax Journal, National Tax Association, vol. 57(3), pages 757-72, September.
    2. McGill, Gary A. & Outslay, Edmund, 2004. "Lost in Translation: Detecting Tax Shelter Activity in Financial Statements," National Tax Journal, National Tax Association, vol. 57(3), pages 739-56, September.
    3. Lenter, David & Slemrod, Joel & Shackelford, Douglas A., 2003. "Public Disclosure of Corporate Tax Return Information: Accounting, Economics, and Legal Perspectives," National Tax Journal, National Tax Association, vol. 56(4), pages 803-30, December.
    4. Hanlon, Michelle, 2003. "What Can We Infer about a Firm’s Taxable Income from Its Financial Statements?," National Tax Journal, National Tax Association, vol. 56(4), pages 831-63, December.
    5. Mills, Lillian F. & Plesko, George A., 2003. "Bridging the Reporting Gap: A Proposal for More Informative Reconciling of Book and Tax Income," National Tax Journal, National Tax Association, vol. 56(4), pages 865-93, December.
    6. Wayne R. Landsman, 2002. "Has the Information Content of Quarterly Earnings Announcements Declined in the Past Three Decades?," Journal of Accounting Research, Wiley Blackwell, vol. 40(3), pages 797-808, 06.
    7. Brown, Stephen & Lo, Kin & Lys, Thomas, 1999. "Use of R2 in accounting research: measuring changes in value relevance over the last four decades," Journal of Accounting and Economics, Elsevier, vol. 28(2), pages 83-115, December.
    8. Guenther, David A. & Maydew, Edward L. & Nutter, Sarah E., 1997. "Financial reporting, tax costs, and book-tax conformity," Journal of Accounting and Economics, Elsevier, vol. 23(3), pages 225-248, November.
    9. Joos, Peter & Plesko, George, 2004. "Valuing Loss Firms," Working papers 562043, Massachusetts Institute of Technology (MIT), Sloan School of Management.
    10. Vuong, Quang H, 1989. "Likelihood Ratio Tests for Model Selection and Non-nested Hypotheses," Econometrica, Econometric Society, vol. 57(2), pages 307-33, March.
    11. Fama, Eugene F. & French, Kenneth R., 2004. "New lists: Fundamentals and survival rates," Journal of Financial Economics, Elsevier, vol. 73(2), pages 229-269, August.
    12. Plesko, George A., 2004. "Corporate Tax Avoidance and the Properties of Corporate Earnings," National Tax Journal, National Tax Association, vol. 57(3), pages 729-37, September.
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