The Taxation of Income from Capital docx

The Taxation
of
Income from Capital
A National
Bureau
of
Economic Research
Monograph
Institut fur
Wirtschaftsforschung
Industriens
Utredn
ingsinstitut
The
Taxation
of
Income from
Capital
A Comparative Study
of
the United States, the
United Kingdom, Sweden,
and West Germany
Edited
by
Country
Team
Directors
Mervyn
A.

King
and
Don
Fullerton
United
Kingdom
Sweden
West
Germany
United
States
Mervyn
A.
King
Jan
Sodersten
Willi Leibfritz
Don
Fullerton
Collaborating
Authors
Julian
Alworth
David
F.
Bradford
Thomas
Lindberg
Michael J.
Naldrett

James
M.
Poterba
.0.
The
University
of
Chicago Press
~
Chicago and London
MERVYN
A.
KING
is
the
Esmee
Fairbairn
Professor
of
Investment
at
the
University
of
Birmingham.
DON
FULLERTON
is assistant pro-
fessor
of

economics
and
public
affairs
at
Princeton
University
and
a
research
associate
of
the
National
Bureau
of
Economic
Research.
The
University
of
Chicago
Press,
Chicago
60637
The
University
of
Chicago
Press,

Ltd.,
London
© 1984 by
The
National
Bureau
of
Economic
Research,
Institut
fur
Wirtschaftsforschung,
and
Industriens
Utredningsinstitut
All rights
reserved.
Published
1984
Printed
in
the
United
States
of
America
91
90 89 88 87 86 85 84 5 4 3 2 1
Library
of

Congress Cataloging in Publication Data
Main
entry
under
title:
The
Taxation
of
income
from
capital.
(A
National
Bureau
of
Economic
Research
monograph)
Bibliography:
p.
Includes
index.
1. Saving
and
investment-
Taxation-United
States.
2.
Saving
and

investment-Taxation-Great
Britain.
3. Saving
and
investment-Taxation-Sweden.
4. Saving
and
investment-Taxation-Germany
(West)
I.
King,
Mervyn
A.
II.
Fullerton,
D.
(Don)
III.
Alworth,
J.
(Julian)
IV. Series.
HJ4653.A3T39
1984
336.24'26
83-17884
ISBN
0-226-43630-6
National Bureau
of

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Contents
Preface
IX
Glossary
of
Notation
xiii
1.
Introduction
2.
The Theoretical Framework
7
3.
The United Kingdom
31
4.

Sweden
87
5.
West Germany
149
6.
The United States
193
7.
Comparisons
of
Effective Tax Rates
268
8.
Conclusions
303
Appendix
A:
Standard
Input
Parameters
for All
Four
Countries
313
Appendix
B: Effective
Tax
Rates
in

Each
Combination
for
Each
Country
318
Appendix
C: Technical
Aspects
of
the
Swedish
Tax
System
321
Appendix
0:
Technical
Aspects
of
the
United
States
Tax
System
326
References
329
Author
Index

339
Subject
Index
341
vii
Preface
In early 1979
Martin
Feldstein suggested
that
the
general approach
of
Mervyn King's Public Policy
and
the Corporation (1977) could be used to
compare
effective marginal tax rates for several different countries. Since
the
existing studies
had
employed different
methods,
thus making inter-
country
comparisons
hazardous,
we decided to launch a study based
on

a
common
method
that
might
shed
light
on
the
significant economic differ-
ences
among the
tax systems in four
major
economies
that
have experi-
enced
different degrees
of
economic
success-the
United
States, the
United
Kingdom, Sweden,
and
West
Germany.
In this

book
we
report
the
results
of
that
enterprise,
undertaken
with the
combined
financial and
human
resources
of
the
National
Bureau
of
Economic Research
(NBER)
in
Cambridge,
Massachusetts, Institut ftir Wirtschaftsforschung
(IFO)
in
Munich, West
Germany,
and
the

Industriens Utredningsinstitut
(lUI)
in
Stockholm,
Sweden. In addition, we gratefully acknowledge financial
support
from
the
National Science
Foundation
under
grant numbers
SES791420
and
SES8025404.
Our
first meeting was held at
NBER
in August 1979. This meeting
included
Helmut
Laumer
and
Willi Leibfritz from
IFO
in
Germany,
Gunnar
Eliasson
and

Jan
Sodersten from
lUI
in Sweden, Mervyn King
and
John
Flemming
from Britain,
and
several
United
States economists
including Alan
Auerbach,
David
Bradford,
Larry Dildine, Martin Feld-
stein,
Don
Fullerton,
Charles
McLure,
John
Shoven,
and
Lawrence
Summers.
Subsequent
meetings were held in Stockholm,
June

1980, in
Munich,
November
1980, in
Cambridge,
August
1981, at the
London
School
of
Economics,
January
1982,
and
again in
London,
June
1982. We
received valuable
comments
and
assistance from participants at each
of
these meetings.
In particular,
though
all
authors
participated in writing the whole
manuscript, we would like

to
acknowledge
the
primary efforts made with
ix
x Preface
respect
to
each
chapter.
The
United
Kingdom
chapter
was written pri-
marily by Mervyn King
of
the
University
of
Birmingham
and
NBER,
by
Michael J.
Naldrett
of
the
University
of

Birmingham
and
later
of
Prince-
ton
University,
and
by
James
Poterba
of
Nuffield College,
Oxford,
and
NBER.
We
received invaluable assistance from E. B.
Butler,
R. M.
Elliss, J. King,
and
P.
Penneck
of
the
Inland
Revenue,
from R.
I.

Armitage
of
the
Central
Statistical Office,
and
from J. S. Flemming
and
J.
Ryding
of
the
Bank
of
England.
The
chapter
on
Sweden
was written primarily by
Jan
Sodersten
of
lUI
and
the
University
of
Uppsala
and

by
Thomas
Lindberg
of
lUI.
We
are
especially
indebted
to
Villy
Bergstrom,
Goran
Normann,
Goran
Raback,
and
Rolf
Rundfelt
for valuable assistance
and
helpful comments.
Con-
tributions
were
also
made
by participants
of
the

research
seminar
of
lUI
and
by
Ragnar
Bentzel,
Christen
Herzen,
Sven-Olof Lodin,
Gustav
Sandstrom, and
Leif
Sundberg.
Primary
authors
of
the
chapter
on
Germany
were Willi Leibfritz
of
IFO
and
Julian
Alworth
of
the

Bank
for
International
Settlements
in Basel,
Switzerland.
We
are
especially grateful to
Heinz
Ludwig
of
IFO
for
research
assistance.
Other
helpful
comments
and
assistance were re-
ceived from
Hans-Georg
Jatzek,
Robert
Koll,
Josef
Korner,
and
Stephan

Teschner.
We
are
also grateful for statistical help from Christa
Bronny
and
Christian
Wagner,
and
from
the
Deutsche
Bundesbank
and
the
Statistisches
Bundesamt.
Don
Fullerton
was
the
primary
author
of
the
United
States
chapter,
though
frequent

assistance was
provided
by
Yolanda
K.
Henderson.
At
several
points
during
our
progress we received help from Alan J. Au-
erbach,
Larry
L.
Dildine,
Daniel
Feenberg,
Martin Feldstein,
Barbara
M.
Fraumeni,
Roger
H.
Gordon,
Dale
W.
Jorgenson,
Lawrence B.
Lindsey,

Charles
E.
McLure,
John
B. Shoven, Martin
A.
Sullivan,
Lawrence
H.
Summers,
and
William Vickrey.
Mervyn King
had
primary
responsibility for
the
introductory
chapters
1
and
2,
and
he
began
the
computer
programming
with Michael
Naldrett

at
the
University
of
Birmingham.
Later
computer
work was
undertaken
at
Princeton
University by
Don
Fullerton,
Michael
Naldrett,
and
Thomas
Kronmiller.
Fullerton
had
primary
responsibility for writing
chapter
7;
tables for
that chapter
were
drawn
up

by
Thomas
Kronmiller.
David
Bradford,
also
at
Princeton,
and
Don
Fullerton
contributed
their efforts
as
the
primary
authors
of
our
concluding
chapter.
Particular
mention
must
be
made
of
Don
Fullerton's
efforts

to
produce
results for each
country
from
the
Princeton
computer
according to a tight schedule.
Again,
although
we
want
to
credit those responsible for each
chapter,
we also wish
to
emphasize
that
this
book
is
a joint
product,
not
a
collection
of
separate

papers.
All
authors
participated in
the
drafting
and
xi
Preface
redrafting
of
the
manuscript
and
in
the
development
of
a common view
on
how best to tackle
the
problem
we set ourselves.
Finally, we would like to express
our
thanks
for
remarkable
efficiency

and
patience
to
those
who
typed various
parts
of
the manuscript: Ingrid
Hensel,
Alice
Pattersson,
Jenny
Saxby,
Judy
Weinberger,
Michael Wick-
ham,
and
Maja
Woxen,
and
to
Annie
Zeumer
of
NBER
for making life as
easy as possible for
the

authors. A last word
of
thanks must go to Randall
M0fck,
who
organized
and
shepherded
the preparation
of
the
final
manuscript.
Glossary
of
Notation
This
glossary includes
notation
defined in
chapter
2
and
used
throughout
the
book.
Notation
that

is specific
to
one
country
and
used in a limited
context
is
defined
at
the
point
where
it
is
used.
A
Present
discounted
value
of
tax savings from
depreciation
allow-
ances
and
other
grants
associated with a
unit

investment.
Ad
Present
discounted
value
of
tax savings from
standard
depreciation
allowances
associated
with a unit
investment.
A
z
Present
discounted
value
of
depreciation
allowances associated
with a unit
investment
(Ad
= TA
z
).
a
Rate
of

tax
depreciation
on
exponential
basis.
a'
Rate
of
exponential
tax
depreciation
before
switch
(=
B/
L).
B
Declining
balance
rate
(=
2
for
double
declining balance).
b
Proportion
of
funds
allocated

to
investment
funds
that
must be
deposited
in
Central
Bank
(Sweden).
ben)
Value
age profile
of
an asset
(Sweden).
C Effective cost
of
an
asset.
Cd
Tax
on
distributed
profits
(Germany).
C
u
Tax
on

undistributed
profits
(Germany).
D
An
annual
amount
of
economic
depreciation
(Sweden).
den)
Average
age
of
retirement
of
machines
(Sweden).
d
1
Dummy
equals
unity if
corporate
wealth taxes deductible from
corporate
income
tax
base;

zero
otherwise.
d
2
Dummy
equals
unity if asset
is
inventories;
zero
otherwise.
fen)
Fraction
of
value
of
asset
retained
after
n years (Sweden).
fi
Proportion
of
cost
of
asset
entitled
to
standard
depreciation

allow-
ances.
f2
Proportion
of
cost
of
asset
entitled
to
immediate
expensing.
13
Proportion
of
cost
of
asset
entitled
to
cash
grant.
xiii
xiv Glossary
of
Notation
G
Total
gross dividends paid.
g

Rate
of
cash
investment
grant.
H Multiplicative coefficient
(H
ebesatz)
for
local business tax (Gewer-
besteuer)
(Germany).
Nominal
interest
rate.
K
Net
capital
stock
(Sweden).
k
Index
for
project
combination.
L
Asset
life.
L
s

Time
of
the
asset's
life for
an
optimal
switch
of
depreciation
method.
Proportion
of
profits
that
may
be
allocated to
the
investment fund
(Sweden).
M
Base
rate
(Messzahl) for local business tax
rate
(Germany).
MRR
Gross
marginal

rate
of
return
on
a
project.
m
Marginal
personal
tax
rate.
m
SB
Hypothetical
tax
rate
where
no
initial tax
credit
is
given (Sweden).
m
SF
Equivalent
tax
rate
(Sweden).
N
Number

of
machines
originally in a
cohort
of
assets (Sweden).
n
Period
of
fiscal
depreciation
(Sweden).
p
Pretax
real
rate
of
return
on
a
project.
p
Mean
of
p.
q
Ratio
of
market
value

to
replacement
cost
(Tobin's
q).
r
Real
interest
rate.
S(u)
Survivor
curve
for
capital assets (Sweden).
s
Posttax
real
rate
of
return
to
the
saver.
T
Total
tax liability.
t Marginal tax
rate
(w/p).
f

Average
marginal
tax
rate
(w/p).
t
e
Marginal tax
rate
on
tax-exclusive basis (w/s).
u
Index
for time.
V
Present
discounted
value
of
profits
of
a
project.
v
Proportion
of
inventories
taxed
on
historical cost principles.

w
Tax
wedge
(p
-
s).
w
Mean
of
w.
We
Rate
of
corporate
wealth tax.
w
p
Rate
of
personal
wealth tax.
Y
Corporate
taxable
income.
z Effective
accrued
tax
rate
on

capital gains.
Zs
Statutory
rate
of
capital gains tax.
zsSF
Equivalent
tax
rate
on
capital gains (Sweden).
Uk
Proportion
of
net
capital stock
attributable
to
kth
combination
of
asset,
industry,
source
of
finance,
and
owner.
~

Growth
rate
in value
of
shares
held
by
investment
fund (Sweden).
xv
Glossary
of
Notation
~
Implied
deduction
against tax base
of
insurance company
(Sweden).
8
Rate
of
exponential
depreciation.
e
Opportunity
cost
of
retained

earnings in
terms
of
gross dividends
forgone.
'A
Proportion
of
accrued gains realized by investors
in
each period.
~
Dividend
yield
of
investment
fund portfolio (Sweden).
1T
Rate
of
inflation.
p
Rate
at
which firm discounts
net
of
tax cash flows.
P
p

Investor's
nominal
discount
rate.
T
Rate
of
corporation
tax.
TL
Tax-inclusive effective local business tax
rate
(Germany).
T
e
Effective tax
rate
on
insurance
company
(Sweden).
T
s
Statutory
corporate
tax
rate
(Sweden).
1

Introduction
A continuous increase in living standards is, in
the
long run,
dependent
upon
a high level
of
investment. As the period
of
sustained economic
growth
enjoyed
in
the
1950s
and
1960s has come to an
end,
governments
in many countries have shown an increasing interest in policies designed
to
stimulate investment
and
productivity.
One
of
the
major
weapons

in
the
government's
armory
is
the
tax system.
The
impediments to savings
and
investment resulting from
the
tax system have been the focus
of
g~owing
concern, especially in
the
periods
of
rapid inflation experienced
in recent years.
It is
not
surprising,
therefore,
that
a great deal
of
attention has been
paid

to
analyzing
the
effects
of
the
tax system on savings and investment.
The
failure
of
most
of
the
developed economies to sustain high growth
rates has led
to
an
increased awareness
of
the lessons we may learn from
each
other.
Is it
true,
for example,
that
countries with the highest rates
of
productivity growth have
the

lowest tax rates on capital income? The aim
of
the
research described in this
book
is
to
compare
the
effective tax rates
levied
on
capital income in
the
nonfinancial corporate sector in four
major
economies: the
United
States, the
United
Kingdom, Sweden, and
West
Germany.
The
study hasentailed a collaborative effort by investiga-
tors working in each
of
the
four countries to ensure as exact a comparison
as possible. This is reflected in

the
fact
that
the
project
has produced a
book
rather
than
a series
of
papers
by individual authors. As far as
possible we have tried
to
ensure
uniformity in
our
treatment
and
compa-
rability
of
our
estimates.
The
existing literature
on
international comparisons
of

tax systems
lacks a
sharp
focus, primarily because the statistics are produced for a
multitude
of
purposes
and
are
not
designed to answer a clearly defined
question.
In
this study we
are
attempting
to
answer
the
question,
What
is
1
2 Introduction
the
distribution
of
tax
rates
levied

on
marginal investment projects in the
corporate
sector?
In
each
country
the
tax system imposes a wedge be-
tween
the
rate
of
return
on
an investment
project and
the
rate
of
return
that
can
be
paid
to
the
investors who financed the project.
When
we

look
at
the
present
value
of
expected taxes relative to the
expected
income from a marginal investment
under
consideration, we
measure
what
might be called a
"marginal
effective tax
rate."
We
com-
pare
this
rate
with an
"average
effective tax
rate,"
defined as
the
ratio
of

observed
taxes
to
income from existing investments.
Our
results indicate
that
the
two
are
very different.
The
average
rate
reflects cash flows
and
tax
burdens,
but
the
marginal
rate
is
more
appropriate
for looking
at
incentives
to
save

and
invest. Also,
many
studies
that
measure
either
of
these
effective tax
rates
have
looked
only
at
corporate
taxes on marginal
or
existing
investments
(see discussion
and
references cited in Fullerton
1983).
Although
we limit
our
study
to
investment in the

corporate
sector,
we
do
not
limit ourselves
to
corporate
taxes. We measure a marginal
effective total tax
rate,
in
the
sense
that
we include
corporate
taxes,
personal
taxes,
and
wealth taxes asociated with
the
income from each
marginal
investment.
In
addition,
we shall see
that

within each
country
the
estimated
mar-
ginal tax
rate
varies
enormously
among
industries,
among
assets,
among
different
sources
of
finance,
and
among
different categories
of
original
investors. A
further
important
question we investigate
is
the
sensitivity

of
the
effective tax
rate
to
changes in
the
rate
of
inflation. No particular
relationship is necessary
here,
and
indeed
we find
that
the
effect
of
inflation varies
enormously
from
country
to country.
Questions
like
these
are
both
interesting

and
important
for an analysis
of
the
effects
of
taxation
on
investment,
but
they have a wider policy
relevance as. well. In
three
of
the
four countries involved in this project
there
have
been
major
reports
in recent years
on
the
structure
of
the tax
system.
In

the
United
States Blueprints
for
Basic Tax
Reform
was pub-
lished in 1977. This official
Treasury
report
examined
the
structure
of
the
United
States
tax system
and
considered
a
number
of
major
reforms.
Simultaneously,
under
the
sponsorship
of

the
Institute for Fiscal Studies,
the
Meade
Committee
produced
its
report
in the
United
Kingdom
(Meade
Committee
1978). This
drew
attention
to
the
haphazard
taxation
of
savings
and
investment
in
the
United
Kingdom
and
recommended

that
the
tax
system
be
reformed
so
that
taxation would be
based
on
expendi-
ture
rather
than
income. A similar conclusion was
reached
in a Royal
Commission
Report
in Sweden in 1976 (Lodin 1976). Although these
reports
were
produced
quite
independently,
there
is
one
striking fact

about
them.
The
phenomenon
that
all
the
reports identified as
of
fun-
damental
importance
for tax
reform
was
the
potential distortion
of
sav-
3
Introduction
ings
and
investment
decisions caused by
the
unsystematic tax
treatment
of
income

from
capital.
To
analyze this
phenomenon
requires a comprehensive
treatment
of
both
corporate
and
personal
taxation.
We
attempt
to provide this
and
to
give empirical
estimates
of
the
size
of
the
tax wedge
between
the return
on
investment

and
the return
on
savings. A study
of
this kind requires
both
a
theoretical
framework
and
a substantial
amount
of
empirical work
to
ensure
comparability
of
our
estimates.
Chapter
2 describes
the
theo-
retical
framework
we have used,
and
the

individual country chapters
(chaps.
3-6)
provide
the
empirical basis for
our
estimates.
The
economic
performances
of
the
four
countries in
our
study have
been
rather
different,
and
they
provide a
contrast
in terms
of
both
tax
systems
and

institutional
background.
These
four countries were chosen
to
provide
a
balance
of
economic
and
political structure
and
to
represent
countries
with very different growth experiences.
The
study was limited
to
four
countries
to
ensure
feasibility
of
the
project,
although we
hope

that
the
methodology
described in this
book
will be applied to
other
countries.
The
approach
we
adopt
is designed
to
complement
existing compari-
sons
of
international
tax systems.
These
are
of
two types. First,
there
are
studies
of
the
levels

of
revenue
raised in different countries by different
types
of
taxes.
The
best
example
of
this type
of
study
is
the
regular
publication
Revenue Statistics
of
Member Countries published by the
Organization
for
Economic
Cooperation
and
Development
(GECD).
This
publication
is

designed
to
provide
an accounting framework within
which
the
total tax
structures
of
member
countries may be
compared.
It
is
not
designed
to
answer
any
particular
question,
and
the
classification
of
taxes by
category
is
inevitably a little arbitrary.
For

our
purpose the
problem
is
that
the
statistics
are
not
collected with a view to providing
information
on
the
incentives
offered
by
the
tax system. Nevertheless,
the
figures
published
by
the
GECD
do
provide a useful starting point for
an
analysis
of
taxes,

and
they
are
used in
the
introductory section
of
each
country
chapter.
The
focus
of
our
study, however,
is
the
empirical
estimation
of
the
incentives to save
and
invest afforded by the different
tax systems,
and
for this we
need
a theoretical framework.
The

second
type
of
international
comparison usually consists
of
de-
scriptions
of
the
tax
code
in different countries as it affects particular
assets
or
types
of
income.
For
example,
there
are
studies
of
the differ-
ences
in
the
tax
treatment

of
dividends,
of
capital transfers,
and
of
capital
gains.
Some
of
these
studies have
been
the
basis for policy
recommenda-
tions.
For
example,
the
European
Economic
Community
(EEC)
has
been
trying
to
harmonize
its

treatment
of
corporate
taxation with respect
to
dividends.
The
drawback
to
this
approach
is
that
to evaluate the
4 Introduction
economic effects
of
the tax system we
need to
take into account a very
long list
of
provisions in the tax code.
One
of
the
problems with the
EEC's
attempts
to

harmonize
corporate
taxation has been
that
to
date
it has
focused far
more
on
the
taxation
of
dividends
than on
the definition
of
the
corporate
tax base. Since
the
provisions for depreciation and allowances
for inflation vary widely among
member
countries, such an approach
is
at
best partiql
and
at worst highly misleading.

To
examine the effects
of
the
tax system
on
investment, we
need
to
take
account
of
a large
number
of
details in
the
tax
code,
including
the
rate
of
corporation tax,
the
nature
and
scope
of
depreciation allowances, the extent to which these are

indexed for inflation, investment tax credits
or
other
cash grants for
investment, regional grants
and
subsidies,
the
system
of
corporation tax
(the
classical versus
the
imputation system, for example), the personal
tax
treatment
of
dividends
and
interest income, capital gains taxation,
wealth taxation,
and
the
tax
treatment
of
particular types
of
investors

such as pension funds
and
insurance companies.
An
exhaustive descrip-
tion
of
the
tax
treatment
of
these different items in each country would be
just
as incomprehensible as the tax codes themselves, so in this study we
have tried
to
set
out
a simple conceptual framework within which we may
analyze
the
effective marginal tax
rate
on
capital income. Not only does
this framework
enable
us
to
bring

together
the different aspects
of
the tax
code,
it also allows us
to
compute
the quantitative significance
of
the tax
system as a whole.
The
size
of
the
marginal tax rate levied
on
investment depends upon
the
way
the
project
is
financed
and
the
identity
of
the supplier

of
finance.
We
have
attempted
to
compute
distributions
of
marginal tax rates using
as weights
the
proportions
of
net
capital stock financed by particular
owners
and
from particular sources.
We
have also examined
the
alloca-
tion
of
investment
among
industries
and
among different types

of
asset.
This
required
an
empirical study into
the
ownership
of
different types
of
securities
and
the
financing
of
industry. In themselves these
data
require-
ments
proved
time consuming
and
are described in detail in individual
country
chapters.
One
of
the
by-products

of
our
study
is
a good deal
of
detailed information
about
the
financing
and
ownership
of
industry in
each country
and
of
the
institutional background against which
our
results may
be
seen. As
part
of
our
study, we used very large
data
sets to
compute

a distribution
of
marginal tax rates
on
individual investors in
each
country,
and
we carried
out
the most systematic study to date
of
shareownership in West
Germany.
We
would stress,
therefore,
that
the
output
of
this research project
should
not
be
seen solely in terms
of
the tax rates we present in
chapter
7.

The
individual country chapters contain a good deal
of
detail
about
the
financing
and
ownership
of
the
corporate
sector
and
of
tax systems so as
5 Introduction
to
allow
the
reader
to place
our
results in context.
To
make this detail
more accessible, we have organized each country
chapter in an identical
fashion, as follows:
1.

Introduction
2.
The
Tax System
2.1
The
Personal Income Tax
2.2
The
Corporate
Tax System
2.3 Tax Allowances for Depreciation
and Inventories
2.4 Estimates
of
Economic Depreciation
2.5 Investment
Grants
and Incentives
2.6 Local Taxes
2.7 Wealth Taxes
2.8 Household Tax
Rates
2.9 Tax-Exempt Institutions
2.10 Insurance Companies
3.
The
Structure
of
the Capital Stock and Its Ownership

3.1
Data
Limitations
3.2 Capital Stock Weights
3.3 Sources
of
Financial Capital
3.4
The
Ownership
of
Equity
3.5
The
Ownership
of
Debt
4. Estimates
of
Effective Marginal Tax Rates
4.1 Principal Results
4.2
Recent
Changes in Tax Legislation
4.3 Comparison with 1960 and 1970
4.4 Comparison with Average Tax Rates
This
arrangement
should enable readers who wish to compare the tax
treatment

of, for example, insurance companiesin eachcountry to do this
by referring to section 2.10 in each country chapter. A glossary
of
notation
is
provided at
the
beginning
of
the book.
The
work
of
the project fell into
three
parts. First, there was the
development
of
the
conceptual framework. Second, there was the collec-
tion
of
data
on
a comparable basis for the computation
of
effective
marginal tax rates. Finally these rates were estimated using a common
computer
program.

The
bulk
of
the time was taken up
in
producing
estimates
of
the
parameters
used in
our
calculations and in ensuring
comparability
of
our
estimates.
The
plan
of
the
book
is
as follows.
The
conceptual framework
is
described in
chapter
2, and the

data
for the individual countries are
discussed in chapters
3-6.
Our
main results concerning effective marginal
tax rates may be found in
chapter
7, and
the
main lessons
of
our
study are
summarized in
chapter
8.
Readers
who wish to focus on the principal
6 Introduction
results
are
advised to
start
with chapters 1, 2, 7,
and
8
and
then
return

to
the
individual
country
chapters
for a fuller explanation.
The
discussion in
chapter
7
compares
the
marginal effective tax rates in
the
four
countries for 1980. In section 4
of
each country
chapter
the
results for 1980
are
summarized,
and
their
sensitivity to alternative
assumptions
is
examined.
For

each
country
we also examine the effect
of
recent
changes in tax legislation
and
provide two sets
of
comparisons.
The
first is with
estimated
marginal effective tax rates for 1960 and 1970,
to
give
some
idea
of
how tax rates have evolved
over
time.
The
second
comparison is with an estimate
of
the
average effective tax rate
on
income

from
corporate
capital in 1980. This comparison shows the difference
between
marginal
and
average tax rates.
Our
aim
is
to
provide sufficient detail
on
both
the
methodology under-
lying
our
study
and
the
data
used so
that
other
investigators may, first,
replicate
the
calculations for
the

same
sample
of
four countries and,
second,
extend
the
analysis to
other
countries. In time we hope to
persuade
governments
or
other
bodies to
adopt
our
methods so as to
produce
regular estimates
of
the
incentive effects
of
taxation.
The
study
should
also be a useful
compendium

of
information not only
about
the tax
system in
each
country
but
also
about
the
structure
of
the
corporate
sector.
It is
more than
two
hundred
years since
Edmund
Burke
wrote
that
"to
tax
and
to
please, no

more
than
to love
and
to be wise,
is
not given to
men."
Our
results will not
make
it easier for governments to please their
electorate,
but
we
hope
they will
make
voters and governments alike a
little wiser
about
the
true
impact
of
tax legislation.
2
The
Theoretical Framework
Our

aim
is
to
examine the incentives to save and invest in the private
nonfinancial
corporate
sector offered by
the
tax system in each country.
Clearly, taxes
are
only
one
of
the
determinants
of
capital formation, and
our
four countriesexhibit many
important
differences beyonddifferences
in
the
taxation
of
capital income.
But
the
structure

of
the tax system
is
often cited as
an
impediment
to
economic growth,
and
it
is
under
the
direct control
of
government. Taxation can affect many economic deci-
sions, including
labor
supply, work effort, enterprise,
and
risk taking, as
well as household savings
and
corporate
investment in real assets. In this
study we focus
on
the
flow
of

private savings into real
corporate
invest-
ment
and
the
flow
of
profits
that
result from this investment back to
households.
We
do
not explicitly discuss
the
effects
of
taxes
on
risk taking
or
work effort,
and
our
analysis
is
limited
to
the incentives to save and

invest. Since
the
exercise
of
"enterprise"
usually involves some invest-
ment-that
is, some sacrifice
of
present
consumption for future
returns-
our
estimated
effective tax rates
bear
closely
on the
incentives
or
disin-
centives provided by government
to
channel resources into entre-
preneurship.
2.1
The
Measurement
of
Effective Tax Rates

The
measurement
of
effective tax rates
is
not straightforward. Popular
discussion tends to concentrate
on
the
tax
burden
on
corporate profits,
especially in periods
of
rapid inflation. This
corporate
tax burden (or
average effective
corporate
tax rate) may be a misleading measure for
two reasons. First, it ignores
the
interaction between personal
and
corpo-
rate taxation.
For
example, interest payments
that

are deductible at the
corporate
level are taxed in
the
hands
of
the
personal sector upon receipt.
7
8 The Theoretical Framework
The
incentives
to
invest
depend
upon
the
combined
weight
of
personal
and
corporate
taxes.
Second,
the
tax
burden
measures
the

observed
tax
rate
on
realized capital income.
It
does
not
measure
the
incentive for
additional
investment
which is a function
of
the
marginal tax rate. In what
follows, we
develop
estimates
of
the
effective marginaltax
rate
on
capital
income
for
each
of

the
four
countries.
To
do
this
requires
a precise definition
of
the margin involved.
The
margin
considered
here
is
a small increase in
the
level
of
real investment
in
the
domestic
nonfinancial
corporate
sector, financed by an increase in
the
savings
of
domestic households.

An
alternative marginal tax rate
would
be
that
applicable
to
an
increase in profits
that
did not result from
an
addition
to
investment
but
that
resulted,
perhaps,
from an
unexpected
increase in selling prices.
Although
the
latter
definition has its place,
the
former
is
preferred

here
because
it
is
the
margin relevant to the incentive
effects
of
taxation.
The
empirical study
is
restricted to domestic savings
and
investment.
International
capital flows
are
important
in a
number
of
areas,
but
the
intricacies
of
double
tax
agreements

and
of
the
accounting behavior
of
multinational
companies
introduce
complexities
that
are
better
deferred
to
a
separate
study.
In
any
event,
the
bulk
of
investment in each
of
the
countries
studied
here
is

financed domestically,
and
the
effective tax rates
presented
below give a fairly accurate picture
of
the
incentives provided
by
the
different
tax systems. Public-sector investment
is
also excluded
from
our
study. Its
determinants
are
unrelated
to
the
tax system,
and
our
focus
is
on
taxation.

Finally, we
examine
only
corporate
investment. This
limitation
means
we ignore
not
only
unincorporated
business
but
also
investment
in residential housing.
Again,
most industrial investment
is
in
the
corporate
sector. Details
of
the
size
of
the
corporate
sector

and
the
importance
of
foreign
ownership
of
domestic capital
are
provided in
the
respective
country
chapters.
To
assess
the
impact
of
taxation
on
investment, two
approaches
may be
identified.
The
first
is
the
econometric

modeling
of
the
process
that
generates
time-series
observations
on
savings
and
investment. A
major
problem
with this
approach
is
the
complexity
of
the
correct
specification
of
tax variables,
not
to
mention
uncertainty,
adjustment

costs,
and
pro-
duction lags.
As
a
consequence,
the
very limited
number
of
observations
that
are
available, even with
quarterly
data,
contain insufficient informa-
tion
for
us
to
be confident
of
identifying
the
underlying process.
More-
over,
the

relation
between
investment
and
taxation
depends
upon corpo-
rate
financial policy
and
on
the
pattern
of
ownership
of
corporate
securities.
There
is
no
unique
cost
of
capital
to
the
corporate
sector
that

is
independent
of
its
ownership
pattern
and
those
other
factors
that
deter-
mine
its capital
structure.
The
second
approach
is
to
compute
directly the tax
"wedge"
between