Part 1 - AL-Tax

International Taxation Handbookthereafter. The entrance at that point cannot be justified and the entry thresholdmust exceed p˜ to compensate periods of supernormal returns and periods of subnormalreturns. The level Γ p˜ will ensure a normal return on average. 11The advantages of the formula above are the facility of computation, given thatthey require only one additional variable, the variance of the returns (which can beconsidered as a join variance of prices, demand, and costs), and the readiness of calculationdue to the possibility of using existing series. On the other hand, McKenzie(1994) has also developed an expression for an METR under risk and irreversibilityof investments. Nevertheless, his derivation is more demanding in informationbecause it ideally needs data on the demand and price of capital variances (althoughhe uses an index of total unsystematic risk). Other kinds of risks, such as market risk,can be added to the cost of capital, equation (2.7), determining a risk premium as thecovariance between the industry and market returns as a whole. Devereux (2003) followsthat approach and derives an expression for the expected pre-tax rate of return.2.3 Backward-looking ETRsBackward-looking effective taxes use data from tax paid on income generated byprevious investments, and hence they are not necessarily linked to future tax paymentson new investments.2.3.1 Average ETRThis methodology employs data on capital income tax paid (T) divided by a measureof the pre-tax income from capital. This ratio can be interpreted as an AETR.Moreover, Sørensen (2004) has shown that, under some assumptions, this tax isequal to the forward-looking AETR.We define the pre-tax total income from capital as p t K t , where p t is the averagepre-tax rate of return and K t is capital stock. The backward-looking AETR can besummarized as:AETR B T t.pK(2.20)The total tax paid is equal to taxable income, given in equation (2.4), multiplied bythe statutory tax rate. Under constant return to scale (using equation (2.7)), we canwrite:T τ ( p δ) K AI.t t t t ttt(2.21)28