Measuring marginal effective tax rates on capital income

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January 15, 2020

Huaqun Li, Kyle Pomerleau

Main conclusions

  • This article updates the calculation of the user cost of capital in the Tax Foundation’s general equilibrium model by including the allocation of equity and corporate debt financing and separating the rate of return required by companies. user cost of capital savers for businesses.
  • This document calculates the marginal effective tax rate for eight types of business investments under current law. We find that the marginal effective tax rates (METRs) on corporate assets are slightly higher than those on non-corporate assets.
  • Comparison of TEMIs under the Tax Cuts and Jobs Act (TCJA) versus the pre-TCJA period indicates that the TCJA temporarily reduces METRs for all asset types and all sales training.
  • Phasing out the temporary provisions of the TCJA will increase marginal effective tax rates on all types of assets, especially in the business sector. From 2026, the weighted average marginal effective tax rate in unincorporated sectors will be about 1.6 percentage points higher than in corporate sectors.
  • This study first examines the marginal effective tax rates of the federal tax system and then includes national and local taxes, such as property taxes and corporate income taxes, to calculate marginal effective tax rates. Adding state and local taxes dramatically increases METRs for all types of assets.

introduction

The literature on measuring the impact of tax policy on the modification of new business investment behavior is based on the concept of user cost of capital developed by Dale Jorgenson (1963)[1] and Robert Hall and Dale Jorgenson (1967).[2] The marginal effective tax rate (METR), a measure of the tax burden based on the concept of the user cost of capital, is commonly used to summarize the impact of tax regimes on business investment decisions.

Changes in taxation, including but not limited to changes in statutory corporate income tax and personal income tax rates, would change the user cost of capital and thus have a marginal impact on investment decisions. The Tax Cuts and Jobs Act (TCJA) of 2017 made a long list of changes to the federal tax system, not only to personal income provisions, but also to provisions affecting business income.

This study will update how the General Equilibrium Model of the Tax Foundation[3] measures METRs on different types of capital investment and how this metric has changed under current law due to TCJA.[4] In this article, we first describe the updates to our measure of the marginal effective tax rate through two changes in the calculation of the user cost of capital. First, the separation between debt financing and equity financing of investment is built into our model framework; second, the user cost of capital framework is broken down into two layers: corporate and personal capital income savers.

Changes in METRs across different types of assets under current law and over the next decade are shown both with and without state and local taxes. The comparison of METRs between different types of assets and forms of business is discussed as in the pre-TCJA law, the current law and over the next decade.

Read the full document

[1] Dale W. Jorgenson, “Capital Theory and Investing Behavior,” The American Economic Review 53: 2 (May 1963): 247-259.

[2] Robert E. Hall and Dale W. Jorgenson, “Tax Policy and Investment Behavior,” The American Economic Review 57: 3 (June 1967): 391-414.

[3] Stephen J. Entin, Huaqun Li and Kyle Pomerleau, “Overview of the Tax Found Foundation’s General Equilibrium Model”, Tax Foundation, April 2018, https://files.taxfoundation.org/20180419195810/TaxFoundaton_General-Equilibrium-Model-Overview1. pdf.

[4] For a full list of the TCJA changes we consider in this document, see Appendix A.

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