The Economic Consequences of Tax Disclosure Regulation: Evidence from FIN 48

Abstract

This study investigates how firms respond to the tax disclosure requirements in the Financial Accounting Standards Board’s Interpretation No. 48: Accounting for Uncertainty in Income Taxes (FIN 48). As a significant change in tax accounting in the United States, FIN 48 drew considerable controversy at the time of its adoption. Due to the concerns that the Internal Revenue Service may use the new disclosure to facilitate tax audits, firms likely reassessed the cost of pursuing aggressive tax policies. This study finds variations among U.S. firms’ tax policy changes in response to the new disclosure requirements across several dimensions, such as firms’ preexisting tax aggressiveness and geographic proximity to IRS offices, as well as the IRS’s continuous monitoring of firms. The magnitude of reactions, which is captured by a spike in cash effective tax rate, and the stickiness of reactions, which is captured by an annual adjustment speed of cash effective tax rate, vary across the three dimensions. The variation in the magnitude and stickiness of reactions suggests a heterogeneous response by U.S. firms to a tax disclosure regulation. The study contributes to the literature on public tax disclosure and the real effects of disclosure regulations.