Pitfalls in the Construction and Use of Effective Tax Rates

41 Pages Posted: 25 Jun 2004 Last revised: 14 Apr 2008

See all articles by David F. Bradford

David F. Bradford

Princeton University, Woodrow Wilson School; NBER; CESifo (Center for Economic Studies and Ifo Institute)

Don Fullerton

University of Illinois at Urbana-Champaign - Department of Finance; National Bureau of Economic Research (NBER); CESifo (Center for Economic Studies and Ifo Institute)

Date Written: June 1981

Abstract

A cost of capital formula can be a useful tool in estimating the effective tax rate on a dollar of marginal investment in a particular industry. There are a number of procedural issues, however, which can greatly affect the resulting estimates. First, tax rate estimates vary with the interest rate used in the formula. Second, the nonlinearity of tax rate formulas may lead to anomalous results. For example, an investment that is actually subsidized may appear to bear a positive tax. Or, tax rates may become arbitrarily large when the project's rate of return approaches zero. Third, effective tax rate results depend on the assumed relationship between inflation and nominal interest rates. Our conclusion is that much sensitivity analysis and specificity are required in studies that undertake to estimate effective tax rates.

Suggested Citation

Bradford, David F. and Fullerton, Don, Pitfalls in the Construction and Use of Effective Tax Rates (June 1981). NBER Working Paper No. w0688. Available at SSRN: https://ssrn.com/abstract=227129

David F. Bradford (Contact Author)

Princeton University, Woodrow Wilson School ( email )

Department of Economics
Princeton, NJ 08544-1021
United States
609-258-1856 (Phone)
609-258-2809 (Fax)

NBER

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

CESifo (Center for Economic Studies and Ifo Institute)

Poschinger Str. 5
Munich, DE-81679
Germany

HOME PAGE: http://www.CESifo.de

Don Fullerton

University of Illinois at Urbana-Champaign - Department of Finance ( email )

1206 South Sixth Street
Champaign, IL 61820
United States
(217) 244-3621 (Phone)

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

CESifo (Center for Economic Studies and Ifo Institute)

Poschinger Str. 5
Munich, DE-81679
Germany

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