How Do Effective Tax Rates Differ Among Investments?įederal tax law distinguishes among different forms of capital income, and ETRs vary significantly as a result. The ETR on capital income generated by businesses is, on average, 29 percent.The ETR on income from owner-occupied housing is close to zero and.The ETR on capital income is, on average, 18 percent.In considering both corporate and individual taxation-but only with respect to the permanent features of federal income tax law in 2014-CBO arrived at the following conclusions: (In this report, capital income consists of receipts minus the cost of goods sold, operating expenses, interest paid, and an allowance equal to the decline in value of capital assets because of economic depreciation-that is, wear and tear or obsolescence.) The higher the ETR, the greater the distortion in investments, holding all else equal thus, the greater the variation (or nonuniformity) of ETRs among different investments, the less likely it is that resources will be used efficiently.įor this report, CBO estimated ETRs on income from marginal investments (those expected to earn just enough, after taxes, to attract investors) in such tangible capital assets as equipment, structures, land, and inventories (assets held for resale). An ETR combines a statutory tax rate with other features of the tax code (various deductions and credits, for example) into a single percentage that applies to before-tax capital income realized over an investment’s lifetime. Those differences reduce economic efficiency-the extent to which resources are allocated to maximize before-tax value.Īn effective marginal tax rate (hereafter referred to as an effective tax rate or ETR) measures an investor’s tax burden on returns from an investment. Current law produces significant variations in the taxation of capital income from different investments, thus leading investors to require higher before-tax rates of return on some investments than on others. When tax rates are high, investors require higher before-tax rates of return and thus forgo investments with lower returns that they otherwise would have made. ![]() The federal tax treatment of capital income affects investment incentives, both for the amounts invested and for allocations among assets.
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