Working Paper: NBER ID: w0688
Authors: David F. Bradford; Don Fullerton
Abstract: A cost of capital formula can be a useful tool in estimating the effective tax rate on a dollar of marginal investment in a particular industry. There are a number of procedural issues, however, which can greatly affect the resulting estimates. First, tax rate estimates vary with the interest rate used in the formula. Second, the nonlinearity of tax rate formulas may lead to anomalous results. For example, an investment that is actually subsidized may appear to bear a positive tax. Or, tax rates may become arbitrarily large when the project's rate of return approaches zero. Third, effective tax rate results depend on the assumed relationship between inflation and nominal interest rates. Our conclusion is that much sensitivity analysis and specificity are required in studies that undertake to estimate effective tax rates.
Keywords: Effective Tax Rates; Cost of Capital; Investment Tax Credit; Inflation; Interest Rates
JEL Codes: H25; H32
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| inflation (E31) | nominal interest rates (E43) |
| nominal interest rates (E43) | effective tax rates (H29) |
| tax structure (H20) | investment returns (G11) |
| depreciation rates and investment tax credits (G31) | effective tax rates (H29) |
| interest rates (E43) | effective tax rates (H29) |