The Impact of Tax Policy Uncertainty on Forecasting

What is it about?

Extensive research shows how tax policy impacts firms' decisions and tax planning. Much less is known about tax policy uncertainty, despite anecdotal evidence that suggests tax policy uncertainty is a serious concern for both managers and market participants. This paper identifies a novel, news-based measure of tax policy uncertainty and validates this measure by correlating it to hand-collected data on tax-related policymaking activity by Congress. We show that tax policy uncertainty has a significant negative impact on analysts' and managers' ability to predict effective tax rates (ETRs). Further, our results indicate an interplay between analysts and managers whereby inaccurate management ETR estimates exacerbate the effects of tax policy uncertainty on analysts. Our study provides evidence that when Congress fails to provide stable tax policy, a resulting cost is impairment of managers' and market participants' ability to assess firms' tax-related fundamentals.

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