Tax Expense Surprises And Future Returns

The authors investigate whether surprises in quarterly tax expense predict future returns, after controlling for surprises in after-tax book income. They find that seasonally-differenced quarterly tax expense, their proxy for tax expense surprise, is positively related to future returns over the next two quarters. They confirm that this anomalous link is separate from other anomalies documented in the prior literature, such as size, book-to-market, accruals, and price momentum, as well as two anomalies related to tax variables. While higher expense might intuitively imply bad news, in this case higher tax expense signals good news as it is positively related to pre and after-tax income.