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Abstract: 

Prior measures of Effective Tax Rates presume that capital investment is undertaken primarily to achieve a marginal economic return. However, a profitable firm may make capital re-investments in order to obtain current tax deductions arising from depreciation or deductible expense. If firms do at times make capital investment primarily to obtain tax deductions, this has substantial implications for tax policy design. For example, multinational firms with surplus capital might be expected to make capital investment into higher-tax jurisdictions in an attempt to offset other sources of income and thereby to harvest the present value of the current and future tax deductions. This effect may be exacerbated if multinational firms expect to use transfer pricing techniques to shift future income out of the higher-tax jurisdiction. An Effective Tax Rate measure modeled along these lines more closely tracks real-world observations of capital re-investment by profitable firms predominantly into higher-tax jurisdictions.

Keywords: Effective Tax Rate, Economic Unit; Economic Rents, Present Value of Tax Deduction, Cash Retention Value

Affiliations:  1: Indiana University; 2: Victoria University of Wellington.