The Predictive Ability of Taxable Income for Future Performance: The Impact of High Tax Planning*

Abstract

This research examines whether high tax planning affects the predictive ability of taxable income for firms' future operating performance. Using US-listed firms for the period 1988 to 2016, this study finds that high tax planning reduces the ability of taxable income to predict future performance, measured as 1-, 2-, and 3-year-ahead operating cash flows. It also shows that high tax planning decreases the incremental predictive value of taxable income for future performance beyond book income and operating cash flows. This study contributes to the existing literature on the informative nature of taxable income and enhances our understanding of how tax planning affects the information content of taxable income, particularly its predictive ability for firms' future performance. These findings suggest that, when using taxable income to predict future performance, financial statement users should consider the level of aggressiveness in firms' tax planning activities.