ABSTRACT The trade‐off literature asserts that managers weigh the direct benefits of tax avoidance against the associated nontax costs. This literature implies each firm has a unique optimal level of tax avoidance that balances these costs and benefits. Our study is the first to document how quickly the average firm moves toward its optimal level of tax avoidance. We find that the typical firm converges toward its optimum at a rate that ranges from approximately 69 to 84 percent over a three‐year period, depending upon model specifications. Consistent with asymmetric levels of frictions across the tax avoidance distribution, we find the speed of adjustment is greater for firms below their optimal level of tax avoidance than for firms above. We perform additional cross‐sectional analyses to provide insight into some of the frictions that prevent firms from adjusting completely to their optimal level of tax avoidance. We generally find growth firms exhibit slower adjustment speeds and provide limited evidence that both multinational firms and income‐mobile firms exhibit faster adjustment speeds.

ABSTRACT We investigate whether tax avoidance becomes more uncertain as the rate of tax avoidance increases. We estimate a system of equations to demonstrate that as firms' pretax income increases, each additional dollar of potential tax results, on average, in 32.8 cents of tax avoided, which we refer to as incremental tax avoidance. Of the incremental tax avoided, 1.4 cents represent additions to the reserve for uncertain tax benefits (UTB reserve), or 4.3 percent of the total incremental tax avoided. We then partition sample firms into groups that prior research suggests engage in higher rates of tax avoidance, and examine the amount of incremental tax avoidance that results in additions to the UTB reserve. Results demonstrate that the percentage of incremental tax avoidance reflecting additions to UTB reserve is not larger for groups engaging in higher rates of tax avoidance, suggesting higher rates of tax avoidance may not be more uncertain. JEL Classifications: H26; M41; M48.

ABSTRACT In this study, we develop a measure of corporate tax avoidance that reduces both financial and taxable income, which we refer to as “book-tax conforming” tax avoidance. We use simulation analyses, LIFO/FIFO inventory method conversions, and samples of private and public firms to validate our measure. We then investigate the prevalence of conforming tax avoidance within a sample of public firms. Results from the validation tests indicate that our measure of conforming tax avoidance successfully captures book-tax conforming transactions. Consistent with expectations, we also find that the extent to which public firms engage in conforming tax avoidance varies systematically with the capital market pressures. Our study develops a new measure of conforming tax avoidance that should be useful in future research and provides new insights on the extent to which public firms are willing to reduce income tax liabilities at the expense of reporting lower financial income.