The Effective Tax Ratio and the Undertaxation of Intangible Investments

Abstract:     
The corporate income tax imposes widely divergent real or effective tax rates on different corporations. The effective tax rate a corporation pays can be measured by an effective tax ratio (ET ratio), which depends upon what proportion of the corporation's total pretax investments are reflected in its capitalized adjusted basis. The paper derives the effective tax ratio from the standard form of internal-rate-of-return reducing effective tax rate.

The effective tax ratio can be estimated from SEC data. Google, Lorillard Tobacco and the makers of Doom III and Grand Theft Auto IV pay effective tax near 10% because most of their investments are expensed intangibles. Wal-mart and Dell Computer pay tax in the middle of the range. Macy's and Jetblue pay effective tax rate near the statutory tax rate. The rates are independent of, perhaps even inverse, to merit.

The wide divergence in tax rates shown by the effective tax ratio means the corporate tax does high excess damage above its production of government revenue. The divergence implies we need to fix the problem of intangibles or abandon tax based on accounting-defined income.

Keywords: Effective tax rate, intangibles, corporate income tax, effective tax ratio

JEL Classifications: H20, H21, H25, M41

Working Paper Series