Part 1 - AL-Tax

Chapter 2AbstractIn this paper we summarize the capital income effective tax rate literature. An effective taxrate (ETR) can be defined as a measure intended to estimate the real tax burden on an economicactivity. Departing from the cost of capital formulation, we describe the developmentof forward- and backward-looking marginal and average tax rates. We shed somelight on the pros and cons of each approach, and we propose some simple extensions: amarginal effective tax with technological progress, an average effective tax with uncertaintyand the entrance of rival firms, and an average effective tax rate on the cost ofproduction.2.1 IntroductionThe main challenge for any empirical researcher studying taxation across countriesis the selection of an appropriate measure for the tax. A priori, he could workwith the statutory tax rates, but given the multiple provisions of the tax codesaffecting the tax base, they do not represent a good approximation of the tax burden,resulting in a usual overestimation of the amount of the effective tax weight. Inparticular, in the case of income from capital, the taxable income differ from the trueeconomic income on various respects. Among them, the most common are: thetreatment of capital gains on realization rather than on an accrual basis generates adeferral which lowers the effective tax burden; the tax depreciation differs from theeconomic depreciation; imputed rental incomes are usually not taxed; etc.To overcome that complexity and to obtain a summary measure that can be comparableand usable in an econometric analysis, economists have been working onthe development of so-called effective tax rates for more than 20 years. Furthermore,those measures are important for the political debate in comparing the situationof local enterprises with respect to foreign competitors.An effective tax rate (ETR) can be defined as a measure intended to estimate thereal tax burden on an economic activity. Several estimates have been constructedin an attempt to find the ‘true’ effective tax rate. This chapter, as an extension ofGérard and Ruiz (2005), aims to summarize all different approaches estimatingeffective tax rates, and to shed some light on their pros and cons.The different measures can be grouped in various forms, depending on whatthey assess or what kind of information they use. The answer to those questionsgives, respectively, the classical separation between marginal ETR vs. average ETRand backward-looking ETR vs. forward-looking ETR. This classification can besketched as in Figure 2.1, although some approaches might be included in morethan one branch. 113