Updated for the 2026-2027 CFA® Level I curriculum.
A company's income statement shows one tax expense number, but analysts look at three different tax rates to understand what that number really means. The statutory rate tells you what the law requires. The effective rate tells you what the company actually recorded. The cash tax rate tells you what it actually paid. CFA Level I tests whether you can calculate each one and explain why they differ.
Quick Answer
To calculate the tax rate from income statement data, divide income tax expense by pretax income for the effective tax rate, or divide cash taxes paid by pretax income for the cash tax rate. The statutory tax rate is the legally required rate in the company's home jurisdiction, found in tax filings or disclosures, not calculated from the income statement. Gaps between these three rates reveal foreign tax exposure, permanent differences, and timing differences in cash tax payments.
Key Takeaways
The statutory tax rate is set by law in the company's home jurisdiction. It is not calculated from financial statements.
The effective tax rate equals income tax expense divided by pretax income (accounting profit).
The cash tax rate equals cash taxes paid divided by pretax income.
Effective tax rate above statutory rate usually signals nondeductible expenses, higher foreign tax rates, or valuation allowance changes.
Cash tax rate below effective tax rate usually signals deferred tax liabilities are growing, meaning tax payments are being postponed.
A stable rate can simplify forecasts, but stability alone does not establish earnings quality. Review the recurring and one-time causes of the rate.
What You Need to Know for CFA Level I
The LOS asks you to calculate, interpret, and contrast these three rates, not just define them.
You must know which rate comes from which source: statutory from law, effective from the income statement, cash from the cash flow statement or tax disclosures.
You need to explain why effective and statutory rates diverge, usually foreign income, permanent differences, or tax credits.
You need to explain why effective and cash tax rates diverge, usually timing differences tied to deferred taxes.
This page does not cover how deferred tax assets or liabilities are created. That belongs to a separate note on deferred tax assets and liabilities.
The most common trap is treating the effective tax rate and the cash tax rate as interchangeable. They answer different questions.
The Three Tax Rates Analysts Use
Statutory Tax Rate
The statutory tax rate is the tax rate imposed by law in the jurisdiction where the company is domiciled. It is a legal rate, not a computed one. For a US-based company, this might be the federal corporate tax rate plus any applicable state rate. Analysts treat the statutory rate as a baseline for comparison, not as a number pulled from the income statement.
Effective Tax Rate
The effective tax rate shows the actual tax burden a company recorded relative to its pretax accounting income. It reflects every factor that pushes reported tax expense above or below the statutory baseline, including foreign operations taxed at different rates, nondeductible expenses, tax credits, and changes in valuation allowances. This is the rate most commonly tested and most useful for forecasting future tax expense.
Cash Tax Rate
The cash tax rate shows the taxes a company actually paid in cash during the period, relative to pretax income. Because income tax expense includes both current and deferred tax components, the cash tax rate can differ meaningfully from the effective tax rate. This rate matters for cash flow analysis and for understanding whether a company is deferring tax payments into future periods.
Calculating Each Rate
where:
Income Tax Expense: the total tax expense reported on the income statement, including current and deferred components,
Pretax Income: accounting profit before taxes, also called income before taxes, and
Cash Taxes Paid: the actual cash outflow for taxes, typically disclosed in the cash flow statement or the income tax footnote.
The statutory tax rate has no formula using financial statement data. It is a known legal rate disclosed in the tax footnote, usually in the effective tax rate reconciliation.
Interpreting Differences Between the Three Rates
Effective Rate vs. Statutory Rate
When the effective tax rate is higher than the statutory rate, the company is facing a heavier tax burden than its home-country law alone would suggest. Common causes include income earned in higher-tax foreign jurisdictions, nondeductible expenses, or an increase in the valuation allowance against deferred tax assets.
When the effective tax rate is lower than the statutory rate, the company is benefiting from factors that reduce its tax burden. Common causes include tax credits, income earned in lower-tax foreign jurisdictions, or a decrease in the valuation allowance.
Effective Rate vs. Cash Tax Rate
When the cash tax rate is lower than the effective rate, cash paid is below tax expense. Possible explanations include deferred tax expense, growth in current taxes payable, refunds, or payment and settlement timing. The gap alone does not identify a DTL increase or establish when additional cash tax will be paid.
When the cash tax rate is higher than the effective rate, cash paid exceeds tax expense. The company may be settling a prior payable, making advance payments, or experiencing deferred tax benefits or reversals. Reconcile the current and deferred components before interpreting the cause.
Working Example
Orion Manufacturing reports the following for the fiscal year:
Pretax income: $500 million
Income tax expense: $120 million
Cash taxes paid (from the cash flow statement): $95 million
Home-country statutory tax rate: 21%
Step 1: Calculate the effective tax rate.
Step 2: Calculate the cash tax rate.
Step 3: Compare to the statutory rate.
Effective tax rate (24%) is 3 percentage points above the statutory rate (21%).
Step 4: Compare effective rate to cash tax rate.
Cash tax rate (19%) is 5 percentage points below the effective tax rate (24%).
Orion's 24% effective rate exceeds its 21% statutory baseline, while its 19% cash rate is below its effective rate. Nondeductible expenses, jurisdictional income mix, credits, and DTA realizability can affect the first comparison. Deferred tax and current-tax payment movements can affect the second. The figures establish the size of each gap; the tax note is needed to explain its source and persistence.
Explain the Five-Percentage-Point Gap
Orion's total tax expense exceeds cash paid by $25 million. Suppose its tax note shows current tax expense of $100 million and deferred tax expense of $20 million, all in profit or loss. Current taxes payable rise from $10 million to $15 million, with no other movements.
The $25 million gap equals 5% of $500 million pretax income, reconciling the 24% effective rate with the 19% cash rate.
Now consider a different company with the same pretax income, tax expense, and cash payment. If its deferred tax expense is zero and current taxes payable rise by $25 million, the same rate gap arises entirely from unpaid current tax. The two rate figures alone cannot distinguish these cases.
The forecast implication depends on the source. A payable build may settle soon; a temporary difference reverses according to its underlying asset or liability; a refund or prior-year settlement follows another timetable. Inspect the tax and payable disclosures before projecting a cash-tax catch-up.
Common Exam Traps
Using the wrong denominator
The effective and cash tax ratios in this note divide by pretax income, not net income and not total revenue. Dividing by the wrong base produces a rate that looks reasonable but is wrong.
Treating cash tax rate and effective tax rate as the same number
They answer different questions. Effective tax rate reflects accrual accounting. Cash tax rate reflects actual cash outflows. The exam often tests whether you can explain the gap, not just calculate both rates.
Assuming a higher effective rate than statutory rate always signals a problem
It often just reflects foreign operations taxed at higher rates or specific nondeductible items. It is not automatically a red flag.
Confusing this topic with deferred tax asset and liability mechanics
This page covers the three rates and their interpretation. How deferred tax assets and liabilities arise, and how valuation allowances work, is covered in a separate note.
Forgetting that the statutory rate is not calculated
Some candidates try to derive the statutory rate from the income statement. It is a legal rate, disclosed in the tax footnote, not a computed ratio.
Practice Question
A company reports pretax income of $400 million, income tax expense of $100 million, and cash taxes paid of $84 million during the year. The company's home-country statutory tax rate is 25%. Which statement is most accurate?
The effective tax rate is below the statutory rate, and the cash tax rate exceeds the effective tax rate.
The effective tax rate equals the statutory rate, and the cash tax rate is below the effective tax rate.
The effective tax rate equals the statutory rate, and the cash tax rate is above the effective tax rate.
Correct Answer: Option B
. This equals the statutory rate of 25%.
. This is below the effective tax rate of 25%.
Explanation: The effective tax rate matches the statutory rate exactly in this case, showing no net difference from the statutory-rate tax charge. Individual reconciling effects may still offset each other. The cash tax rate is lower than the effective tax rate, which shows cash paid is below recorded expense. A growing DTL is one possible cause; the figures alone do not identify the cause.
Option A: Incorrect. This choice assumes the effective rate is below statutory and the cash rate exceeds the effective rate, which reverses both relationships found in the calculation.
Option C: Incorrect. The effective rate does equal the statutory rate here, but the cash tax rate is below, not above, the effective tax rate.
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FAQs About Effective, Statutory, and Cash Tax Rates
Why do companies have different effective and statutory tax rates?
Effective tax rates diverge from statutory rates because of factors like foreign income taxed at different rates, nondeductible expenses, tax credits, and changes in valuation allowances. The statutory rate only reflects the home-country legal rate.
How do you calculate tax rate from income statement figures?
Divide income tax expense by pretax income to get the effective tax rate. This uses only income statement line items. The cash tax rate requires cash taxes paid, which usually comes from the cash flow statement or tax footnote, not the income statement alone.
Why would a company's cash tax rate be lower than its effective tax rate?
A lower cash rate means cash taxes paid are below reported tax expense. Deferred tax can explain part of the gap, but changes in current taxes payable, refunds, advance payments, and prior-year settlements can also matter. Check the tax reconciliation and payment roll-forward.
Is a high effective tax rate always a bad sign?
Not necessarily. A high effective tax rate relative to the statutory rate often reflects foreign operations in higher-tax jurisdictions or specific nondeductible items. Analysts look at the cause before judging it as a problem.
Where do you find the statutory tax rate for a company?
The statutory tax rate is disclosed in the income tax footnote, often as the starting point in the effective tax rate reconciliation table. It is not calculated from financial statement line items.