Pre-tax Rates Research Articles

The tax shield increases the interest rate

We study the general equilibrium implications of the corporate tax shield in a growth economy that taxes household income and firm profits and redistributes tax revenues. Our stylized model predicts that in general equilibrium the tax shield's reduction of the corporate after-tax borrowing rate is counteracted (but not fully eliminated) by an increase in the pre-tax rate.

전세사기 발생원인 및 법적 방지방안에 관한 연구

In the last 2~3 years, the sale price of real estate has plummeted, and the news about the crime of rental fraud continues day after day. In this situation, the contents of the government’s recent measures about rental scam can be broadly summarized as prevention, support, crackdown, and strengthening of punishment. Among them, preventive measures include reducing the pre-tax rate subject to tax return guarantee from 100% to 90%, and preventing senior mortgage loans after the contract by providing information on each stage of the contract. If the landlord enters into a contract for the sale of the leased object with a third party during the rental(or lease) period, preventive measures such as requiring the tenant to notify the tenant in advance must be written in the standard contract and provided by the Association of Certified Realtors. On the other hand, it seems necessary to reconsider measures such as providing the credit information of the landlord to individuals such as authorized brokers or lowering the rental price rate in connection with the purchase of rental guarantee insurance. In addition, it is necessary to regulate certified brokers and real estate consulting firms that lead real estate transactions in close contact with the general public, and it is necessary to create institutional conditions for the general public to conduct real estate transactions transparently.

Does Tax‐Favored Policy Improve the Profitability of Environmental Protection Firms? An Empirical Study from the Implicit Tax Perspective

AbstractAn implicit tax is a reduction in the pretax rate of return driven by tax preferences. With increasingly stringent requirements of sustainable development, Chinese government actively promotes environmental protection with the direct corporate income tax rate preferences, which provide a unique opportunity to examine whether implicit taxes remain a significant tax cost in the environmental protection industry. This paper finds the existence of implicit taxes in environmental protection firms and the market structure impedes the realization of implicit taxes. The market power and market concentration reduce the negative effect of tax preferences on the firm's pretax rate of return. The environmental protection firms with lower competition bear lower implicit taxes. These findings are important to evaluate the effectiveness of the tax incentives on environmental protection firms and other tax‐favored industries.

An examination of the relationship between implicit taxes and market structure: Evidence from Chinese listed companies

ABSTRACT An implicit tax is a reduction in the pre-tax rate of return driven by tax preferences on an investment. The extant research demonstrates existence of implicit taxes at corporate level, but prior studies have drawbacks in tax preferences measure. This study takes the unique advantage of Chinese corporate tax rate preference setting to address research method problems. By employing the propensity score matching and multivariate regression analysis, we demonstrate the existence of implicit taxes in Chinese listed firms and the market structure impedes the realisation of implicit taxes. The market power and market concentration reduce the negative effect of tax preferences on the firm’s pre-tax rate of return.

Investor asset valuation under a wealth tax and a capital income tax

We study how a capital income tax and a wealth tax affect an investor's valuation of a company's stock in an efficient international capital market. Using a one-period model, a model of infinite horizon where the asset generates a future cash flow that is a martingale, and a finite horizon model where we abandon the martingale assumption, we find that a wealth tax and/or a capital income tax do not lead investors to value an investment differently from untaxed investors. Investors who seek a higher pre-tax rate of return due to capital taxes harm their own wealth.

Summaries of Papers in This Issue

Summaries of Papers in This Issue

Post- to Pre-Tax Discount Rates: Not a Simple Conversion

Abstract It is widely accepted that financial markets tend to make assessments of value on expectations of post-tax cash flows, since that is what equity investors receive. There is however, from time to time, a need to ascertain and apply a pre-tax discount rate to discount pre-tax cashflows. Examples include (i) the assessment of regulatory returns and (ii) impairment testing of cash generating units. This paper highlights the implicit assumptions inherent in the most commonly applied shorthand method of determining pre-tax discount rates before considering modifications to create a more realistic assumption set. The paper concludes with the derivation of a shorthand formula for finite life project cashflows, which often require a pre-tax discount rate. The author agrees that while all the cash flows should be modelled on a post-tax basis and then back solved, using an iterative approach, to find the actual pre-tax rate, where a shorthand is required the formulae discussed in this paper can be applied, provided the limitations are understood.

The Impact of the 2017 Act's Tax Rate Changes on Choice of Entity

In an ideal world, the effective tax rates for C corporations and partnerships would be identical and tax rates would not play a role in selecting an entity for conducting a business. Unfortunately, the new statutory rates in the 2017 Tax Act and the 20% § 199A deduction have not leveled the playing field. This article shows that the choice of an appropriate entity under the effective tax rates of the 2017 Tax Act is complex and is affected by whether an entity will retain and reinvest its earnings, by how long this retention will occur, by the availability of the § 199A deduction, by the applicability of the 3.8% Medicare surtax, and by the pre-tax rate of return on retained earnings. The article calculates the effective tax rates for various scenarios using these variables and shows that a partnership frequently has a lower effective tax rate than a C corporation if earnings are distributed annually. The picture changes, however, if a C corporation will retain earnings. A C corporation that is a qualified small business (“QSB”) corporation under § 1202 will have a lower effective tax rate than a partnership if investors intend to sell their stock in lieu of having the corporation distribute its earnings. If a C corporation is not a QSB or investors do not wish to sell their stock, the C corporation will still have a lower effective tax rate if investors permit the corporation to retain earnings for sufficiently long periods. The article calculates the retention periods for various scenarios using the above variables and shows that a C corporation will have lower effective tax rates if it retains its earnings for 3.9 years to 30.1 years, depending on the circumstances. Investors may view such retention periods as too long, if they have short-term investment horizons. The result is that the 2017 Tax Act has made it more difficult to predict which choice of entity will have the lowest effective tax rate in the long run. Tax planning has become more important, not less.

Organizational Capital: The Most Important Unsettling Issue in Tax

“Organizational Capital” argues that a uniform income tax would not do material damage, but that our income tax does serious distortion by reducing pretax returns for different companies by very divergent amounts. If an investment has zero adjusted basis, then tax does not reduce the pretax rate of return. To reduce pretax rate of return by the statutory tax rate, the adjusted basis of the investment must equal the present market value of the investment (using the internal rate of return as the discount rate). There is also a rule of proration under which a tax basis of half of present value implies that pretax returns are reduced by half of the statutory tax rate. This creates an uneven playing field with relative advantages and punishments unrelated to the merits of the underlying investments. With publicly traded corporations, we can rely on the smart market to determine the fair market value of a corporation’s assets There would be incremental improvements by capitalizing the costs of advertising, research and development and top management compensation, and amortizing the costs over some arbitrary period. But to reach a truly level playing field, it is also necessary to capitalize the organizational advantages of big business. From its inception in the nineteenth century, big business was able to marry mass production to mass distribution under professional management and immediately dominate each industry upon entry. Publicly traded companies can accumulation capital for the largest, most profitable projects. The importance of ending tax distortions of intangibles fully justifies moving to a mark-to-market system in which corporations are taxed until the basis for their assets equals the market capitalization of their stock and debt.

Capital Gains Taxes and Expected Rates of Return

Prior literature predicts a positive relation between firms' expected pre-tax rates of return and investor-level capital gains tax rates. We show that this relation is more nuanced than suggested by prior literature and that in three circumstances the relation can actually be negative. The first circumstance is when a firm's systematic risk is very high. The second circumstance is when the market risk premium is very high. The third circumstance is when the risk-free rate of return is very low. The circumstances arise because, in addition to reducing investors' expected after-tax cash proceeds, capital gains taxes reduce the risk that investors associate with the expected after-tax cash proceeds.

Capital Gains Taxes and Expected Rates of Return

ABSTRACTPrior literature predicts a positive relation between firms' expected pre-tax rates of return and investor-level capital gains tax rates. We show that this relation is more nuanced than suggested by prior literature and that in three circumstances the relation can actually be negative. The first circumstance is when a firm's systematic risk is very high. The second circumstance is when the market risk premium is very high. The third circumstance is when the risk-free rate of return is very low. The circumstances arise because, in addition to reducing investors' expected after-tax cash proceeds, capital gains taxes reduce the risk that investors associate with the expected after-tax cash proceeds.

Capital Gains Taxes and Expected Rates of Return

Prior literature predicts a positive relation between firms’ expected pre-tax rates of return and investor-level capital gains tax rates. We show that this relation is more nuanced than suggested by prior literature and that in three circumstances the relation can actually be negative. The first circumstance is when a firm’s systematic risk is very high. The second circumstance is when the market risk premium is very high. The third circumstance is when the risk-free rate of return is very low. The circumstances arise because in addition to reducing investors’ expected after-tax cash proceeds, capital gains taxes reduce the risk that investors associate with the expected after-tax cash proceeds.

The Net Present Value Effective Tax Rate

This study reexamines two common measures of the effective tax rate on a marginal project that generates positive cash flows early in its life and negative cash flows late in its life. The long-run average accounting effective tax rate, which compares the ratio of tax expense to pretax accounting earnings over the life of the project, can be misleading because it does not adjust for the time value of money, thereby overweighting the effects of future cash flows. The economic effective tax rate on the project, which compares the project’s pretax and after-tax internal rates of return, can yield multiple or economically meaningless solutions. In addition, it can misleading because the pretax internal rate of return discounts future cash flows at a rate other than the project’s cost of capital. We characterize a new effective tax rate measure based on net present values rather than internal rates of return or accounting earnings. Our measure indicates that projects with long-run negative cash flows are tax-disfavored, because the present value of the project’s future cash flows decays more rapidly than the value of the asset that generates revenue.

Aggregate capital productivity in the US economy, 1964-2001

In the decomposition of the US macroeconomic pre-tax rate of profit as the product of profit share and capital productivity, this paper considers the role of capital productivity over the period 1964–2001. The primary finding is that prior to 1982 capital productivity fell because capital deepening proceeded faster than labour productivity growth, whereas from 1982 to 1997 the opposite occured. If, prior to 1982, the US economy was characterised by Marx-biased technical progress, what requires explanation is why labour productivity continued to grow after 1982 in the absence of sufficient capital deepening. The paper explores various hypotheses, contrasts neoclassical and classical notions of technical change, and investigates the robustness of its results to the productive–unproductive distinction and to accounting for changes in capacity utilisation.

Measuring tax distortions with neutrality-based effective tax rates

In public economics, effective tax rates (ETRs) are often used to measure the combined effects of tax rates, tax bases, and the time effect of taxation. Until now, the modelling of comparable figures for revealing tax effects and tax-induced distortions is not solved satisfactorily. This paper derives an ETR approach based on neutral tax systems. In contrast to traditional measures of ETRs, the neutrality-based ETR discloses preferential or discriminatory taxation of investments regardless of their pre-tax rate of return. Moreover, comparing different ETRs exposes the degree of tax-induced investment distortions.

Tax Efficiency and Marginal Effective Tax Rates for Capital Income

Standard specification of marginal effective tax rate (METR) as expected pretax minus after-tax rates of return divided by pretax rate of return contains a fundamental flaw rendering the measure useless except in a few special cases. The current study exposes the flaw and introduces an alternative specification robust for a wider class of scenarios. Analysis reveals that asset characteristics such as service life or time-paths of pretax cash flow and economic depreciation are irrelevant to METR. Tax neutrality requires immediately expensing capital investments. Second best policy uses one tax depreciation schedule for all assets irrespective of underlying economic depreciation patterns.

Strategies for Maximizing Estate Wealth

The conventional wisdom that using tax-sheltered accounts such as Keogh plans, IRAs, 401(k) programs, etc. is an excellent way to save for retirement but a poor way to accumulate an estate is shown to be incorrect at least under a variety of reasonable circumstances. It is shown that net estate wealth (i.e., after income and estate taxes) generally will be greater by saving in such plans compared to saving in conventional (i.e., taxable) accounts. The misconception arises because the net wealth left after taxes on two estates of equal size at death will be less when a significant part of the assets are in tax-sheltered plans, but this is not a fair comparison because if all other factors (e.g., income and consumption during the accumulation period, pre-tax rates of return, etc.) are held constant, the estate associated with the tax-sheltered investment will unequivocally be larger at the time of death. It is also shown that saving in tax-sheltered plans during the early years of the lifecycle, followed by saving in a taxable account in the later years, will generate a maximum after-tax transfer to heirs.

Valuing Assets in Retirement Saving Accounts

This paper compares the value of one dollar of an asset held in a tax-deferred account with one dollar of a similar asset held in a taxable account from the standpoint of providing future retirement income. Taxes that are due when assets are withdrawn from some retirement saving plans can make a dollar held inside a retirement account less valuable than a dollar held in a similar asset outside these accounts, particularly for those who are considering withdrawing assets from the tax-deferred accounts in the near future. This effect is more than offset, however, particularly for younger workers, by the benefits of many years of asset growth at pre-tax rates of return. This paper calibrates the value of the tax burden, and the benefit of compound growth, for assets held in retirement accounts, and describes the differences in relative valuation for households of different ages.

An Application of the Scholes and Wolfson Model to Examine the Relation Between Implicit and Explicit Taxes and Firm Market Structure

A firm can take advantage of preferential tax provisions to lower its explicit tax burden. In the absence of market frictions, this differential tax treatment gives rise to differences in pre-tax returns across investments, defined as an implicit tax (Scholes and Wolfson 1992). Market structures that are other than perfectly competitive can impede the realization of implicit taxes (which represent lower pre-tax returns) by allowing firms to earn extra-normal after-tax returns (Wilkie 1992). This study estimates implicit tax rates and investigates the relation between a firm's implicit tax rate and two factors: (1) the pre-tax rate of return, and, (2) the potential market power of the firm, which could provide the opportunity to shift implicit (and explicit) tax burdens from the firm to consumers or labor. The results indicate that implicit taxes are significantly negatively related to the pre-tax rate of return and firm market structure characteristics. The interaction of pre-tax returns and firm market structure characteristics is positively related to implicit taxes, indicating that firm market structure may lead to a weakening of the strict negative relation between implicit taxes and pre-tax returns.

Personal Taxation and Investment Incentives in a Small Open Economy

A simple portfolio model is used to investigate the effects of personal taxes on real investment incentives in a small open economy with large and small firms. When shares in large firms can be traded internationally and their rate of return is exogenously determined on international equity markets, a tax on the return on riskless bonds will induce a portfolio shift from bonds to shares in large firms. This shift reduces the impact of the bond tax on the required rate of return on shares in domestically owned small firms, provided that returns on shares in small and large firms are positively correlated. The total impact of the bond tax may even change from a negative to a counter-intuitive positive one if the “beta” between the returns on small and large firms is above unity. A personal tax on equity returns does in general have an ambiguous impact on the pre-tax rate of return requirement of domestically owned firms. An exogenous rate of return on large company shares is shown to enhance the possibility for the equity tax to reduce the required pre-tax rate of return in small domestic firms. A sufficient condition for a negative relationship is again that the “beta” between the returns in small and large firms is above unity.