Tax Reform and the Cost of Capital

By Dale W. Jorgenson; Kun-Young Yun | Go to book overview

4 Effective Tax Rates

In this chapter we summarize the tax burden on capital income by means of the marginal effective tax rate introduced by Auerbach and Jorgenson ( 1980). An effective tax rate represents the complex provisions of tax law in terms of a single ad valorem rate. This tax rate is based on the social rate of return, defined as income per dollar of capital, adjusted for inflation and depreciation but not for taxes. This social rate of return can be compared with the corresponding private rate of return, which excludes all tax liabilities at both corporate and individual levels. The effective tax rate is defined as the difference between the social and private rates of return, divided by the social rate of return, net of inflation.

We calculate private and social rates of return for assets in the corporate, non-corporate, and household sectors. Private rates of return on capital differ among sectors, since they depend on the debt-capital ratio of each sector. However, these rates of return are the same for all types of assets within a given sector. The social rates of return depend on asset-specific provisions of US tax law, such as the rate of the investment tax credit and the present value of tax deductions for capital consumption allowances, and may differ among assets within a sector. We also present tax wedges, defined as differences between social and private rates of return, and marginal effective tax rates, defined as ratios of the tax wedges to the social rates of return, net of inflation, for all types of assets.

In Section 4.1 we estimate social rates of return for 65 types of assets -- the 51 types of depreciable business assets listed in Table 3.19, the 11 types of consumer durables listed in Table 3.20 and 3 types of non-depreciable assets (farm inventories, non- farm inventories, and land) in the household, non-corporate, and corporate sectors. We assume that interest rates on net debt in the household, non-corporate, and corporate sectors are equal to the interest rate on corporate bonds of the Baa class. We also

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Tax Reform and the Cost of Capital
Table of contents

Table of contents

  • Title Page iii
  • Foreword v
  • Preface vii
  • Contents xiii
  • Tables xv
  • 1 - Introduction 1
  • 2 - Taxation of Income from Capital 17
  • 3 - The US Tax System 39
  • 4 - Effective Tax Rates 110
  • 5 - Summary and Conclusion 153
  • References 166
  • Author Index 176
  • Subject Index 178
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