Available online at www.sciencedirect.

com

The International Journal of Accounting 47 (2012) 155 – 167

Are Multinational Corporate Tax Rules as Important

as Tax Rates? ☆
Namryoung Lee a , Charles Swenson b,⁎
a
Korea Aerospace University, South Korea
b
Marshall School of Business, University of Southern California, United States

Received 23 December 2008

Abstract

Previous research has documented the influence of statutory tax rates on international firms' effective
tax rates, or ETRs. We add to this body of research by examining common factors of the income tax base,
which affects ETRs. Specifically, this study examines the determinants of effective tax rates for publicly
traded companies based in European Union (EU) countries. The time period examined is after 2004, when
all EU firms were required to use standardized accounting principles under International Financial Report-
ing Standards (IFRS). We find that, across EU countries, such factors are relatively consistent with factors
found in studies of U.S. companies' effective tax rates, which include inventory, leverage, depreciation tax
shield, and R&D intensity. We also find that the presence of country book-tax conformity rules increases
effective rates. Importantly, our finding that such tax base (or rule) effects are at least as important as rate
effects adds to the international debate about uneven tax structures around the globe.
© 2012 University of Illinois. All rights reserved.

JEL classification: M41; H20

Keywords: Tax avoidance; Multinational taxation

1. Introduction

The purpose of this study is to decompose, at least in part, the differential aspects of
international tax systems, which may result in gaps between statutory and effective corporate
tax rates. Previous studies of multinationals' effective tax rates (ETRs) have documented the
effects of country statutory tax rates (STRs) on country ETRs. This study goes beyond this pre-
vious work by documenting the effects of income tax base rules on ETRs. Because the data is
☆
The authors acknowledge the helpful comments of Mingyi Hung, Bob Trezevant, participants at the University of
Illinois Tax Research Symposium, two anonymous referees, and the editor.
⁎ Corresponding author.
E-mail address: Cswenson@marshall.usc.edu (C. Swenson).
0020-7063/$ - see front matter © 2012 University of Illinois. All rights reserved.
doi:10.1016/j.intacc.2012.03.001
156 N. Lee, C. Swenson / The International Journal of Accounting 47 (2012) 155–167

drawn from financial statements, we control for the noise that varying countries' accounting
rules may have by examining firms that have standardized accounting rules. Utilizing current
effective tax rates, we examine EU-based firms, who were all required to use IFRS starting in
2005. Similar to studies of U.S. ETRs (and controlling for time and industry membership), we
find that firm debt tax shield, depreciation, and R&D intensity all significantly affect effective
tax rates for EU firms. Additionally, we find that country book-tax conformity rules tend to in-
crease effective tax rates. Most importantly, we find that such tax base rules are as important
as statutory rates in terms of their effects on current effective tax rates.
The reason that the above finding is important is because many countries seem to place
much greater significance on statutory rates; in an effort to be competitive, numerous coun-
tries have continually reduced their corporate income statutory tax rates, or STRs, over
time (we document these rate deductions in Section 3). Such rate reductions were a very
common trend in European countries as well, who (in part to stay competitive with U.S.
rates 1) dropped their statutory rates as a whole from near 40% to below 35% during this
same period. Also during this time period, worldwide statutory rates tended to be above effec-
tive tax rates and gaps between statutory and effective rates varied widely by country. This
latter finding implies that country-specific rules, or tax base effects, are significant and can
act as differentiators in terms of attracting investment into a country.
Popular press and research reflects this focus on statutory rates. For example, the Tax
Foundation (2009) states: “An increasing amount of economic evidence suggests that dramati-
cally cutting the U.S. corporate tax rate . . . would make U.S. firms more competitive abroad. . . .
Until high tax countries like the United States, France, Great Britain, and Japan lower their
corporate tax rates, they will continue to lose ground” (p. 2). Numerous popular references
to tax rates abound, including then presidential candidate John McCain who in a September
26, 2008 debate with Barack Obama focused on the perceived non-competitiveness of the
United States due to high statutory tax rates. 2
From an international tax policy perspective, any empirical finding that rules defining
the tax base are as important as the statutory rate effect on ETRs implies that any conclusions
based on STRs alone are incomplete. For example, countries attempting to attract businesses
by lowering STRs, but continuing to have unfavorable tax base rules, may have only limited
success. 3The assumption that only STRs are relevant would be true under certain circum-
stances, such as the decision to accelerate income or expenses into a year with a lower STR.

1
Examining this EU trend in lowered statutory rates, Global Head of KPMG's Tax Practice Loughlin Hickey
said, “The accession of 10 new members to the EU in 2004, and the continuing efforts of the EU judicial system
to break down barriers to free movement of capital, seem to have combined to increase tax competition among EU
member states. There is a clear contrast with other parts of the world where borders are less permeable, but even
so, the global trend seems to be stable or declining tax rates.” See interview in the Irish business web portal,
Finfacts Ireland at: http://www.finfacts.com/irelandbusinessnews/publish/article_10005465.shtml.
2
Senator McCain stated: “Right now, American business pays the second-highest business taxes in the world,
35 percent. Ireland pays 11 percent. Now, if you're a business person, and you can locate any place in the world,
then, obviously, if you go to the country where it's 11 percent tax versus 35 percent, you're going to be able to
create jobs, increase your business, make more investment, et cetera. I want to cut that business tax. I want to
cut it so that businesses will remain in — in the United States of America and create jobs.”
3
The debate as to statutory rates implicitly assumes that statutory rates are marginal rates on economic activity.
The reader is also referred to Fullerton (1980), Devereaux and Griffith (1998), and Gordon, Kalambokidis, and
Slemrod (2003) for discussions of marginal effective rates on investments.
 N. Lee, C. Swenson / The International Journal of Accounting 47 (2012) 155–167 157

However, much economic activity is affected by tax rules, which in turn affect marginal effec-
tive rates on activity. For example, if a new investment is debt financed, country laws regard-
ing interest deductibility have an effect on the marginal cost of debt, and thus the marginal cost
of the investment. Accordingly, if two countries have identical STRs but one has a limit on the
amount of interest that can be deducted, the latter country would have a higher marginal rate
for that investment.
Similarly, where such an investment results in the acquisition of assets subject to deprecia-
tion, if one country allows more rapid depreciation than the other, that country's marginal effec-
tive rate on investment 4 is lower than that of the other country, ceteris paribus. Similar marginal
rate arguments can be found for other major across-country tax accounting differences, such as
inventory accounting methods and subsidies for research and development. Additionally, coun-
try book-tax conformity rules may affect marginal effective rates, if firms complying with such
rules tend to trade off tax savings for increased financial reporting income. 5

2. Prior multinational ETR Research

There is a considerable amount of literature on U.S. ETRs, which we will only briefly
examine here. The U.S.-based studies suggest that depreciation tax shield (proxied for
by property, plant, and equipment), debt tax shield (proxied by leverage), size, growth
(proxied for by return on assets), inventory, and R&D intensity all contribute to lowered
tax burdens. As discussed later, we include such variables in our analysis to see if such
tax base effects influence EU firms' ETRs in a similar manner.
Over the last ten years, a number of studies have examined multinationals' effective tax
rates. Nichodeme (2001) used firm level data to estimate ETRs for EU, Japanese, and U.S.
companies from 1990–1999. He found that there was a significant gap between statutory
and effective rates across firms and time and that Japanese companies had the highest ETRs,
followed by the United States. The following EU countries also had high ETRs: Germany,
Italy, the Netherlands, and Finland. Other EU countries had ETRs lower than the United States.
Altshuler, Grubert, and Newlon (2001) used IRS tax return data to estimate effective rates
of U.S. multinationals operating in foreign countries from 1984 through 1992. They found
that ETRs varied significantly by country and were below statutory rates. A number of studies
have examined components of taxation and how they can be optimized. Bartelsman and
Beetsma (2003) show, for U.S.-based multinationals, that increases in tax rates can be offset
by firms manipulating reported profits (e.g. through transfer pricing). Bretschger and Hettich
(2002) examined data from 1967–1996 for 14 OECD countries and found that globalization
reduced taxes as opportunities for multinational tax planning (e.g., transfer pricing) increased.
Reinforcing Bretschger and Hettich (2002), Slemrod (2004) used macro data and found that
there is a declining dispersion of average effective rates across countries over time.
Rego (2003) found that multinational U.S. corporations with more extensive foreign
operations have lower worldwide ETRs than other firms do. Rego also found that higher
4
It is important to note that the definition of marginal ETR used by economists should not be confused with
GAAP-based ETRs used in many studies (including this one).
5
Our empirical findings, reported later in the paper, imply that, on average, firms (perhaps as a function of country)
chose income-increasing methods at the expense of higher taxes. Why this is the case is a topic for future research.
158 N. Lee, C. Swenson / The International Journal of Accounting 47 (2012) 155–167

levels of U.S. pre-tax income are associated with lower U.S. and foreign ETRs, while
higher levels of foreign pre-tax income are associated with higher U.S. and foreign
ETRs. Collins and Shackelford (1995) find that 34% of their sample of foreign controlled
corporations (FCCs) in the United States reported zero taxable income. However, their
sample also contained FCCs reporting high levels of taxable income. They also found
the taxable income levels of FCCs vary significantly with the worldwide tax incentives
of their foreign parent companies and economic determinants.
Lu and Swenson (2000) and Lee and Swenson (2008), using Global Compustat, document
a wide variation in 86 countries' ETRs during the 1987–2007 time period. Markle and
Shackelford (2009) document such differences as well, using the Osiris database. Using
regression models, they find that ETRs are influenced by a firm's home country statutory
rates, country domicile, industry, and year. They also find some influence on ETRs or STRs
faced by firms' foreign country subsidiaries.

2.1. Unanswered questions

A relatively unexplored and undetermined issue is the influence of factors affecting the
tax base of multinationals' ETRs. Studies of U.S. ETRs have documented the influence of
tax base effects such as depreciation tax shield, interest expense, incentives for R&D, etc. It
is reasonable to conjecture that such factors affect non-U.S. firms' ETRs as well. The policy
implications of this are important. To the extent that such factors have little or no influence on
ETRs, then STRs remain as the primary driver of countries' ETRs. Thus, countries' attempts
to attract or retain businesses can be, ceteris paribus, influenced by lowering STRs. Alterna-
tively, if tax base effects are instead found to be important, then STRs by themselves have less
of an important policy role than thought previously.
Because tax return data is not publicly available, we use financial statement data to proxy for
the following tax base effects: depreciation tax shield; interest expense; inventory tax benefits
(e.g., LIFO or transfer pricing); and R&D tax benefits. To use such financial statement data
on a worldwide basis, differences in country financial accounting principles could add consid-
erable noise. Fortunately, an international data set exists without such potential noise: firms
based in EU countries that were required to use IFRS after 2004. Thus, we examine all publicly
traded EU companies' financial data from 2005–2007 as reported on Global Compustat. 6 , 7

2.2. EU tax rules

Our examination of EU countries' tax rules during this time period (from the
PricewaterhouseCoopers International Tax Summaries 8) indicates that all countries allow de-
duction of interest expense, all offer some type of depreciation tax shield (via expensing or
rapid depreciation), most offer some sort of tax benefit for R&D, and most allow varying
6
As with U.S. firms, EU firms can make elections, change accruals, etc. (all within the bounds of IFRS) which
can add noise to any ETR analysis. This cannot be controlled for here.
7
While the data allows for comparability in terms of financial accounting data, we freely acknowledge that we
trade off some power insofar as we are able to utilize only three years of data.
8
Available online at www.pwc.com.
 N. Lee, C. Swenson / The International Journal of Accounting 47 (2012) 155–167 159

use of LIFO for inventory accounting. With respect to inventory, it is also assumed that multi-
national EU firms are able to use tax-advantaged transfer pricing arrangements to at least some
degree. Table 2 9 summarizes the foregoing rules by country. As shown, there is an enormous
variability in by-country tax depreciation and inventory rules, as well as tax incentives for
R&D. Table 1 also reports statutory and effective tax rates, across the time period examined,
for each of the 23 EU countries. Here we see significant variations as well, with statutory
(effective) rates at 10% (11%) for Cyprus and 35% (29%) for France, at the extremes.
However, the above tax benefits can be limited to the extent that the country requires book-
tax conformity. In such a case, if we assume that the firm chooses to maximize financial earn-
ings, accounting methods will be chosen that actually may increase taxable income and thus
taxes. To estimate the effects of book-tax conformity, we use Hung's (2001) overall measure
of book-tax conformity for EU countries during this period. Hung (2001) examined a number
of EU book-tax conformity rules and then developed an overall score. We include this score
as a control variable, positing that the higher this score, the higher the firm's effective tax
rate, since the firm will make book income-increasing accounting choices. This method is dis-
cussed in the Appendix A. 10

3. Data and general analysis

Before discussing our methodology, it is insightful to examine trends in global tax rates, as dis-
cussed in the Introduction. As shown in Table 2, using Compustat Global for all publicly traded
firms for the 86 countries represented, we document a drop in statutory corporate tax rates from
35.5% to 29.4% from 1990 to 2007. EU countries also reduced STRs in this time period. The
Table also shows that ETRs were consistently below STRs, as discussed in the Introduction.
Our financial data is derived from Compustat Global for all EU firms from 2005–2007.
This sample is intended to reduce measurement error due to differences in home country
accounting rules, which could affect both ETRs and our independent variables. In contrast
to other countries, all EU firms were required to use IFRS starting in 2005.
Compustat Global reports each company's financials expressed in the company's home
country numeraire (e.g., French francs), although the majority of our sample firms report in
euros. If the firm has multinational operations, all such operations are translated to the
home country numeraire. To control for such price differences across countries, any finan-
cial statement variables are deflated by the firm's assets or sales, which are also expressed
in the same numeraire. 11 The ETR is the current income tax expense (in the home country
numeraire) divided by the pretax net income (also in the home country numeraire). By
9
Detailed tables, by country and method, are reported in our online Appendix A at: https://msbfile03.usc.edu/
digitalmeasures/cswenson/intellcont/Appendix%20to%20Accompany%20Swens on%20Lee-1.pdf.
10
We were unable to find English-version discussions of book-tax differences in interest expense treatment. We
implicitly assume that such differences do exist, similar to those in the United States (e.g., the disallowance as a
tax deduction of certain acquisition indebtedness).
11
Of course, measurement error is created to the extent that within-country price level movements cause a
difference in the current year financial statement variable (e.g., cost of goods sold) measured in current dollars,
whereas total assets are a composite of price levels from the acquisition years of the assets. Because we cannot
make any reasonable assumptions as to years of acquisition of assets, we chose not to translate countries’ finan-
cials into a common currency such as the U.S. dollar.
160 N. Lee, C. Swenson / The International Journal of Accounting 47 (2012) 155–167

Table 1
Tax characteristics by EU country a 2005–2007.
Country Average STR Average CETR Accelerated LIFO or other tax-favored Favorable tax
depreciation inventory method allowed? treatment for
allowed? R&D?
Austria 0.2500 0.2196 No Yes No
Belgium 0.3300 0.2548 Yes Yes N/A
Cyprus .1000 0.1114 No Yes N/A
Czech Republic 0.2467 0.2573 Yes No Yes
Germany 0.2500 0.2832 No Yes No
Denmark 0.2700 0.2202 Yes N/A N/A
Spain 0.3417 0.2454 No No Yes
Estonia .2250 0.1789 No N/A N/A
France 0.3406 0.2946 Yes No N/A
United Kingdom 0.3000 0.2107 No No Yes
Greece 0.2867 0.2830 Yes No N/A
Hungary 0.1600 0.1242 No No Yes
Ireland 0.1250 0.1471 No No Yes
Italy 0.3300 0.3813 Yes Yes N/A
Lithuania .2000 0.2872 Yes Yes N/A
Luxembourg 0.2200 0.2222 No Yes N/A
Netherlands 0.2887 0.2413 Yes N/A N/A
Poland 0.1900 0.1948 No Yes N/A
Portugal 0.2500 0.1913 Yes No No
Romania .1600 0.0908 Yes Yes Yes
Slovakia 0.1900 0.2076 Yes N/A N/A
Slovenia .2200 0.1634 Yes N/A Yes
Sweden 0.2800 0.2345 Yes Yes N/A
**N/A: unable to determine from English versions of law.
a
Detailed tables, by country and method, are reported in our online Appendix A at: https://msbfile03.usc.edu/
digitalmeasures/cswenson/intellcont/Appendix%20to%20Accompany%20Swenson%20Lee-1.pdf.

examining current ETRs (where current tax expense is the numerator), we measure differences
in book and tax accounting methods.

3.1. Examining the factors affecting ETRs

Prior research has found a number of factors that affect U.S.-based firms' ETRs. We use
the factors described in one of the more recent U.S. ETR studies, Gupta and Newberry
(1997), who examine factors very similar to those in other U.S. ETR studies. The ability
to reduce taxes through LIFO can be proxied by relative levels of inventory. Similarly,
the ability to use transfer pricing should reduce ETRs. Here, we proxy this capability as
the firm's ending inventory; firms with no inventory will have no ability to use transfer
pricing, whereas the higher the inventory, the larger the possible tax management through
transfer pricing. The amount of debt tax shield (measured as leverage ratio) reduces taxes
due to the deductibility of interest in virtually every country.
The amount of depreciation tax shield, proxied as total property, plant, and equipment,
reduces taxes since every country (see Table 1) allows deductions for depreciation. R&D expen-
ditures have a tax-favored status in all EU countries, that is, firms can reduce taxes by spending
 N. Lee, C. Swenson / The International Journal of Accounting 47 (2012) 155–167 161

Table 2
Worldwide average ETR by year for 86 countries. 1990–2007.
Data Year Mean ETR Number of Firm-Years Mean
STR
1990 0.3639 7399 0.3549
1991 0.3490 7848 0.3508
1992 0.3564 8002 0.3490
1993 0.3429 8410 0.3482
1994 0.3282 9556 0.3460
1995 0.3250 10,440 0.3469
1996 0.3144 12,325 0.3398
1997 0.2980 14,005 0.3315
1998 0.2890 14,327 0.3268
1999 0.2819 15,265 0.3148
2000 0.2779 15,234 0.3122
2001 0.2749 14,640 0.3029
2002 0.2727 15,044 0.2990
2003 0.2677 15,227 0.2973
2004 0.2589 15,376 0.2956
2005 0.2578 14,945 0.2895
2006 0.2603 14,476 0.2890
2007 0.2462 5943 a 0.2936
Total 0.2915 218,462 0.3177
a
The number of observations declined in 2007 because at the time of this analysis Global Compustat had
collected calendar year end company data but not yet fiscal year end data.

on R&D (many EU countries offer a tax credit; see Table 1). Net operating loss (NOL) carry
forwards from prior years reduce ETRs. However, since Global Compustat does not report
NOLs, we eliminate firms with negative pretax incomes to eliminate the influence of NOLs.
We also include control variables (used in U.S. tax-avoidance studies): size (natural logarithm
of total assets), return on assets, and industry membership dummy variables. Finally, as noted
in Section 2.2, we examine the effects of by-country book-tax conformity requirements.
3.2. Econometric model

Consider a “traditional” panel data model that takes into account both time and unit-
specific variations. Firm i's current effective tax rate in year t can be described as:
X n Xn
CETRi;t ¼ a þ at YRt þ βj INDj þ β2 STRt;c þ β3 SIZEi;t þ β 4 ROAi;t þ β 5 LEV i;t
t¼1 j¼1

þβ6 PPEi;t þ β 7 INV i;t þ β 8 RDint i;t þ β 9 OBCDcc þ ac þ ε i;t ; ð1Þ

where variable definitions are as follows:

CETR Current income tax expense/Pretax income, calculated by (Global Compustat data
23-data25)/data21 12

12
By excluding the deferred portion of tax expense from the numerator of ETR, we are able to isolate book-tax
accounting differences. We winsorize CERTs, excluding those above 1.00 or below − 1.00.
162 N. Lee, C. Swenson / The International Journal of Accounting 47 (2012) 155–167

INV Inventory/lagged assets = data66/lag(data89)

LEV Long-term liabilities/lagged assets = data106/lag(data89)
SIZE Natural log(total assets) = ln(data89)
ROA Pretax income/lagged assets = data21/lag(data89)
PPE Net plant, property, and equipment/lagged assets = data76/lag(data89)
RDint Research and development expense/sales = data52/data1
STR Statutory tax rate for country c and year t
OBTC Overall book-tax conformity score (Hung index) for country c
αc country-specific effects (either fixed or random effects)

In this specification, we examine the direct effects of the statutory tax rate, inventory,
leverage, depreciation tax shield, and research and development (R&D) tax benefits, and
also take into account whether such benefits may be offset insofar as the country's account-
ing system requires book-tax conformity utilizing Hung's (2001) measure of book-tax
conformity. 13 Here, the higher the conformity, the higher the firm's ETR, since firms
will trade off tax-minimizing choices for financial reporting income increases. Finally,
the α c coefficient allows for country-specific effects in a “traditional” panel analysis spec-
ification (Hsiao, 2003).

3.3. Descriptive statistics

Means and standard deviations for data used in our subsequent regression are reported
in Table 3. Correlation coefficients for the same data are reported in Table 4. Median and
mean STRs are much higher than CETRs, consistent with prior results for U.S. firms.
While the range of STRs is relatively narrow at 4% (rounded), the range of CETRs is
much higher, at 34%. Although we eliminated firms with negative net incomes or negative
tax expense from the sample, undoubtedly part of this variability is due to variations in firm
profits, which we control for with SIZE and ROA.

4. Regression results

Table 5 shows regression results 14 for CETR. For comparison purposes, ordinary least
squares (OLS) and country random effects 15 results are also shown. All aggregate figures,
which are in the home country numeraire, are deflated by assets, lagged total assets, or
sales (see notation in Eq. (1)) to reduce currency effects. Results are remarkably similar across
econometric specifications. Model F statistics are all significant at 0.001. For both regressions,
larger home country STRs are mechanically associated with larger CETRs, as expected. What
is interesting to note is that only 36% of each 1% increase in CETR is explained by STRs,
which suggests that tax rules account for 64% of the variation in CETRs.
13
It is also worth noting that if a country had complete book-tax conformity, we would not observe differences in
effective and statutory rates.
14
Absent from our explanatory variable is intangible assets, which can provide tax shields through amortization.
Country accounting practices for intangibles vary so widely that inclusion of this variable created highly distor-
tionary effects (which were not statistically significant) on all other variables.
15
Hausman tests indicated that random effects models were much better fits to the data than fixed effects models.
 N. Lee, C. Swenson / The International Journal of Accounting 47 (2012) 155–167 163

Table 3
Descriptive statistics of current effective tax rates and explanatory variables. EU Firms, 2005–2007.
Variables CETR INV LEV SIZE ROA PPE RDint STR
Mean 0.3063 0.2156 0.1499 7.8109 1.1582 0.3064 0.0044 0.2870
Median 0.1637 0.2541 0.1694 8.7368 0.0551 0.2940 0.0028 0.2600
Std. deviation 0.3442 0.2958 0.0857 1.9084 32.3768 0.2881 0.0282 0.0379
Quartile 1. 0.1341 0.2478 0.1615 8.7249 0.0179 0.0827 0.0026 0.2600
Quartile 3. 0.1987 0.2639 0.1781 8.7709 0.2983 0.3506 0.0028 0.3400
Variable definitions:
CETR = Current income tax expense/Pretax income, calculated by (Global Compustat data.
23-data25)/data21.
INV = Inventory/lagged assets = data66/lag(data89).
LEV = Long-term liabilities/lagged assets = data106/lag(data89).
SIZE = Natural log(total assets) = ln(data89).
ROA = Pretax income/lagged assets = data21/lag(data89).
PPE = Net plant, property, and equipment/ lagged assets = data76/lag(data89).
RDint = Research and development expense/sales = data52/data1.
STR = Statutory tax rate.

In general, factors found to affect U.S. CETRs also affect multinationals' CETRs
(leverage, 16 PPE, magnitude of inventories, and R&D intensity) all significantly reduce
CETRs. Book-tax conformity rules also have an affect consistent with expectations; the
Hung (2001) overall book-tax conformity variable increases CETRs, as firms in such coun-
tries appear to opt to trade off tax savings for income-increasing accounting choices. On
average, such overall book-tax conformity rules increase CETRs by approximately 1%.
This implies that EU firms were willing to trade off tax savings to increase financial earn-
ings by approximately 1%, on average.
To test the relative importance of STRs versus each of the various tax rules (tax base
effects), we use two metrics. First, we report mean sum of squares (MSS) for each variable
next to its parameter estimate in Table 5. Examining MSSs allows comparison of the rel-
ative variation in the dependent variable attributable to an explanatory variable. The results
show that for the tax base variables, R&D intensity is easily the most important, with the
highest MSS. Since R&D results in extra tax benefits in many EU countries (including
credits, which are direct reductions of tax), this result is not surprising. The overall
book-tax conformity variable's MSS shows that this variable easily has much lower ex-
planatory power than the tax base variables. Perhaps most important is the STR variable
compared to the tax base variables. Here, the combined MSS of the tax base variables is
six times higher than that of the STR variable, and the STR variable actually has lower
MSS than both R&D intensity and leverage. Our second method is to perform individual
F tests. These tests, reported in Table 6, confirm that the coefficients for the STR are not
equivalent to the tax base variables.

16
All countries allow deduction of at least some portion of interest paid. For some countries, while equity is tax-
favored to investors (dividends are taxed at a lower rate, credits are given for taxes paid by the corporation, etc.),
there is no direct tax advantage to the corporation from equity.
164 N. Lee, C. Swenson / The International Journal of Accounting 47 (2012) 155–167

Table 4
Paired correlations between variables. EU firms, 2005–2007.
Variables CETR INV LEV SIZE ROA PPE RDint STR
CETR 1.0000
INV − 0.3375 ⁎ 1.0000
LEV − 0.8210 ⁎ 0.3129 ⁎ 1.0000
SIZE − 0.9652 ⁎ 0.3419 ⁎ 0.8352 ⁎ 1.0000
ROA − 0.0139 0.0218 ⁎ 0.0255 ⁎ 0.0204 ⁎ 1.0000
PPE 0.7314 ⁎ 0.3061 ⁎ −0.5336 ⁎ − 0.6911 ⁎ 0.0007 1.0000
RDint 0.0614 ⁎ − 0.2699 ⁎ −0.0937 ⁎ − 0.3298 ⁎ 0.0006 −0.2406 ⁎ 1.0000
STR 0.9584 ⁎ − 0.3198 ⁎ −0.8285 ⁎ − 0.9487 ⁎ − 0.0280 ⁎ 0.6164 ⁎ 0.1660 ⁎ 1.0000
Variable definitions:
CETR = Current income tax expense/Pretax income, calculated by (Global Compustat data 23-data25)/data21.
INV = Inventory/lagged assets = data66/lag(data89).
LEV = Long-term liabilities/lagged assets = data106/lag(data89).
SIZE = Natural log(total assets) = ln(data89).
ROA = Pretax income/lagged assets = data21/lag(data89).
PPE = Net plant, property, and equipment/lagged assets = data76/lag(data89).
RDint = Research and development expense/sales = data52/data1.
STR = Statutory tax rate.
⁎ Significant at 0.05 level or better.

We also examine the overall impact of STR versus the tax base variables. One method
we use is to perform F tests on restrictions on the regression model, which are reported in
the top panel of Table 7. While these tests do not settle whether STR or tax base variables
are relatively equal in their impacts on CETR, they do shed light on the coefficient impacts.
The first two F tests clearly reject the hypotheses that either the STR, or the tax base effects,
accounts for all explanatory power relative to the other. The third column shows that that the
coefficients of STR and the sum of the coefficients of the tax base variables are not equal. To
examine overall model explanatory impact, we run separate regressions in an analysis of
covariance (ANCOVA) to test the hypothesis that the explanatory power of the tax rules
variables (INV, LEV, PPE, and RDint) are statistically equivalent to that of STR. Results
reported in the lower panel of Table 7 show that the results of an F test of the difference be-
tween the two models is .9101, indicating the difference between the two is not significant.
This finding supports our conjecture that country-specific tax base effects (or rules) have at
least as much explanatory value as statutory rates on tax burdens for EU countries.

5. Conclusion

Similar to studies of U.S. CETRs (and controlling for time and industry membership),
we find that firm debt tax shield, depreciation, and R&D intensity all significantly affect
ETRs for EU firms. Additionally, we find that country book-tax conformity rules tend to
increase effective rates. Most importantly, we find that such tax base rules are potentially
as important as statutory rates in terms of their effects on ETRs.
From an international tax policy perspective, our finding that rules affecting the tax base
have as important an effect as the statutory rate implies that any conclusions based on
 N. Lee, C. Swenson / The International Journal of Accounting 47 (2012) 155–167 165

Table 5
Regression results: factors affecting CETR for EU firms, 2005–2007. (t-statistics in parentheses, coefficients
rounded).
Variable Ordinary Least Squares Ordinary Least Squares Random Effects Random Effects
(expected sign) (OLS): parameter (OLS): mean sum of (RE): parameter (RE): mean sum of
estimates squares estimates squares
(Constant) 0.2806 0.0006 0.2806 0.0006
(9.41)⁎⁎⁎ (9.41)⁎⁎⁎
INV(−) − 0.2319 0.0965 −0.2319 0.0965
(− 12.27)⁎⁎⁎ (− 12.27)⁎⁎⁎
LEV(?) − 0.0612 0.0153 −0.0612 0.0153
(− 4.88)⁎⁎⁎ (− 4.88)⁎⁎⁎
SIZE(?) − 0.0045 0.0145 −0.0045 0.0145
(− 4.76)⁎⁎⁎ (− 4.76)⁎⁎⁎
ROA(+) 0.0001 0.0001 0.0001 0.0001
(0.13) (0.13)
PPE(−) − 0.0555 0.0131 −0.0555 0.0131
(− 4.53)⁎⁎⁎ (− 4.53)⁎⁎⁎
RDint(−) − 0.1930 0.2236 −0.1930 0.2236
(− 18.68)⁎⁎⁎ (− 18.68)⁎⁎⁎
STR(+) 0.4268 0.0524 0.4268 0.0524
(9.04)⁎⁎⁎ (9.04)⁎⁎⁎
OBTC(+) 0.0102 0.0053 0.0102 0.0053
(2.87)⁎⁎ (2.87)⁎⁎
Model R2 0.6816 0.6824
Year Dummies Yes Yes
Industry Yes Yes
Dummies
Variable Definitions:
CETR = Current income tax expense/Pretax income, calculated by (Global Compustat data.
23-data25)/data21.
INV = Inventory/lagged assets = data66/lag(data89).
LEV = Long-term Liabilities/lagged assets = data106/lag(data89).
SIZE = Natural log(total assets) = ln(data89).
ROA = Pretax income/lagged assets = data21/lag(data89).
PPE = Net plant, property, and equipment/lagged assets = data76/lag(data89).
RDint = Research and development expense/sales = data52/data1.
STR = Statutory tax rate.
OBTC = Overall book-tax conformity score.
Number of observations = 6845.
⁎⁎⁎Significant at 0.01 level.
⁎⁎Significant at 0.05 level.
⁎Significant at 0.1 level.

Table 6
Coefficient equality tests. Statutory tax rate versus tax base variables.
STR vs. Inventory STR vs. Inventory STR vs. Leverage STR vs. R&D intensity
F(2, 6826) = 165.37 F(2, 6826) = 64.47 F(2, 6826) = 55.76 F(2, 6826) = 229.41
Prob N F = 0.0000 Prob N F = 0.0000 Prob N F = 0.0000 Prob N F = 0.0000
166 N. Lee, C. Swenson / The International Journal of Accounting 47 (2012) 155–167

Table 7
Tests of tax base versus tax rate effects.
Panel A: coefficient restriction tests
STR = 1, and (INV + LEV + STR = 0, and (INV + LEV + STR − (INV + LEV +
PPE + RDint) = 0 PPE + RDint) = 1 PPE + RDint) = 0
F(2, 6826) = 221.39 F(2, 6826) = 64.47 F(2, 6826) = 481.74
Prob N F = 0.0000 Prob N F = 0.0000 Prob N F = 0.0000

Panel B: Factors affecting CETR—Analysis of covariance

STR Coefficient Tax Base Coefficients
MSE 0.02531 0.02781
F 0.9101*
*Or, alternatively, 1.10, depending on which factor is in the numerator. Neither is significant at .05, since the
critical F 9,6826 value is 1.88.
Variable Definitions:
INV = Inventory/lagged assets = data66/lag(data89).
LEV = Long-term liabilities/lagged assets = data106/lag(data89).
PPE = Net plant, property, and equipment/lagged assets = data76/lag(data89).
RDint = Research and development expense/sales = data52/data1.
STR = Statutory tax rate.

STRs alone are incomplete. For example, countries attempting to attract businesses by
lowering STRs, but continuing to have unfavorable tax base rules, may have only limited suc-
cess. Of course, countries may create favorable tax structures beyond the use of favorable de-
preciation, inventory, debt, R&D, and book-tax conformity rules by having territorial tax
systems 17 and by using tax incentives. Here, we measure only one such important tax incen-
tive — R&D write-offs and credits.
A limitation of our study is its generalizability: we examine only EU countries and for
only a short time period. We should note, however, that while EU countries represent only
23 of the 86 countries on Global Compustat, these countries represent a significant portion
of market capitalization and are more than 60% of the firm-years available for the time pe-
riod examined. Nonetheless, the results are encouraging insofar as factors affecting ETRs
may be common across countries.

Appendix A. Overall book-tax conformity by EU country: Hung Index. 18 2005–2007

Method
Overall Conformity Score: Tax-book conformity index equals 1 if the resulting number
from the calculation below is greater than 0, and equals 0 otherwise. Score is a function of
the relative weights of the items below.
17
We acknowledge that the use of territorial tax systems is believed to result in lower tax burdens than worldwide
systems; indeed, the UK and Japan decided recently to switch to such systems (although the Obama administration
has decided not to pursue a switch to a territorial system). Empirically modeling such systems is quite problematic,
however, since most countries’ tax systems are a complex combination of the two, which defy strict classification.
18
Table 1, P. 407, Hung (2001).
 N. Lee, C. Swenson / The International Journal of Accounting 47 (2012) 155–167 167

Item Rating method Weight

Average consensus estimate of the 1 — Strong; 0.5 — Moderate/ 60%
relation between tax and Significant;
financial reporting. 0 — Weak
Do deferred taxes exist? 1 — No deferred tax; 0.5 — Limited; 20%
0 — Yes/recognize
Does legal form dominate substance? 1 — Yes; 0.5 — Sometimes; 0 — No 5%
Is additional accelerated 1 — Yes; 0.5 — Limited; 0 — No 5%
depreciation allowed?
Do amortization periods depend 1 — Yes; 0.5 — Limited; 0 — No 5%
on tax laws?
Does lease capitalization depend 1 — Yes; 0.5 — Limited; 0 — No 5%
on tax law?

*We utilized scores reported in Hung (2001; Table 2, p. 408) and adjusted according to
changes in tax laws from 2005 to 2007 to create 0, 1 scores for Overall Book Tax Conformity,
or OBCT.

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