The Persistence, Forecasting Ability, and Valuation Implications of the Tax Change Component of Earnings

Andrew P. Schmidt
Arizona State University

Abstract: I examine whether and under what circumstances changes in net income caused by changes in ETRs (the tax change component) persist and aid in forecasting future earnings. I decompose the tax change component of earnings into an initial and revised portion, which I hypothesize to have differential persistence and forecasting implications. Finally, I utilize the Mishkin (1983) procedure to determine if the market recognizes the forecasting implications of the differential persistence of each tax change component. I find that the initial tax change component is more persistent for future tax changes than the revised tax change component. The initial tax change component is useful in forecasting future earnings, while the revised tax change component is not. Finally, the Mishkin (1983) procedure indicates that the market underestimates the persistence of the revised tax change component.

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