Greater numeric tax disclosure conducive to better information environment, research finds

Firms reporting more tax numbers are found to be more transparent and have reduced errors and dispersion of implied effective tax forecasts, an American study has revealed.

In her research paper, Tax numbers and ETR forecasting, North Carolina State University assistant professor Carly Burd analysed a sample of 7,944 firm-year observations in 2,099 unique firms between fiscal years 2012 and 2019, and found that numeric tax disclosure improves transparency in a way that narrative tax disclosure does not.

The paper explored the properties and consequences of numeric tax disclosures.

“This study examines the role of numeric tax disclosure in firms’ financial statements by documenting both its determinants and its implications for analysts’ effective tax rate forecasts,” Burd said.

“While research finds that firms with aggressive or opaque tax strategies increase narrative disclosure to signal transparency, my findings suggest numeric disclosure may offer a substantive mechanism for improving tax transparency.”

The assistant professor found that tax information frictions are not reduced by a greater emphasis on narrative tax disclosure.

“[This highlights] an important trade-off between numeric detail and strategic narratives.”

Through her investigation, Burd found that this relationship is driven by more tax numbers in the financial statement footnotes rather than in fact financial statements.

“These findings suggest firms’ tax information environment improves with a greater volume of numeric tax-related disclosures,” the paper said.

Further, the results of the study revealed that when firms hold tax rate complexity constant, greater numeric detail is conducive to better analyst tax forecasting.

“Firms report more tax numbers when tax accounts are more material and subject to greater reporting requirements.”

Burd found that a greater volume of tax numbers reflects a trade-off between mandatory reporting requirements and proprietary disclosure costs.

In firms with more complex and less predictable tax rates, there was less disclosure of tax numbers, particularly where discretion is highest in tax footnotes. The findings revealed this was a consistent pattern in firms that limit numeric detail once mandatory requirements are met, likely due to concerns surrounding sensitive tax information disclosure.

“While firms report more tax numbers when tax accounts are more material, firms with more complex and less predictable tax environments provide fewer tax numbers, particularly in the footnotes, where discretion is highest,” it revealed.

Through these findings, for firms with more complex tax rates, Burd suggested they increase numeric disclosure volume to improve reporting.

“Tax disclosure provides meaningful benefits to market participants …I find that firms reporting more tax numbers exhibit lower analyst effective tax rate forecast errors and dispersion.”

“... analysts devote more attention to taxes as tax rate complexity increases, suggesting that additional numeric detail may enhance transparency, once mandatory reporting requirements are met.”

Burd concluded that tax-related numbers do not significantly vary with mandatory disclosures related to Tax Rate Complexity.

“In this sense, as the firm’s broad information supplied to investors increases, the information processing and analysing required to use the information may also increase, resulting in a larger effective tax rate forecast error.”

“[The findings highlight] the importance of detailed footnote-level numeric information for tax forecasting, consistent with evidence that analysts rely on information in the tax footnotes.”

“The results indicate that firms or policymakers can aid tax transparency by requiring more numeric information to be reported, especially in the tax footnote,” she said.