Order Code RS21706
January 12, 2004
CRS Report for Congress
Received through the CRS Web
Historical Effective Marginal Tax Rates on
Capital Income
Jane G. Gravelle
Senior Specialist in Economic Policy
Government and Finance Division
Summary
Effective marginal tax rates on investment are forward-looking estimates that
project over the lifetime of an investment what share of the return will effectively be
paid in taxes. These rates can differ significantly from average tax rates measured by
dividing tax liability by income, because they are affected by timing. Effective tax rates
fell from the early 1950s through the mid-1960s, rose until the early 1980s, and then
dropped. They have stayed about the same until relatively recently, when they fell to
an all-time low with bonus depreciation, relief of double tax on dividends, and lower
marginal tax rates. This report will be updated as warranted.
The tax rates which determine investment activity are marginal tax rates on new
investment. They are calculated by projecting the path of a new investment and
discounting the flow of income and taxes. They take into account the effects of statutory
tax rates, depreciation rules, investment subsidies, and inflation. The method is to
compare the internal rate that discounts the flow to the current value of investment with
taxes (the after-tax return) and the rate without taxes (the pre-tax return); the difference
between these rates divided by the pre-tax return is the effective tax rate.
Table 1 shows the estimated tax rates from 1953 to 2003. Column 2 presents
estimates of the corporate firm-level tax; if depreciation were allowed at economic rates
and there were no subsidies, this rate would equal the corporate statutory tax rate.
Column 3 reports estimates of the total rate on corporate investment, accounting for the
deductibility of interest at the firm level and the taxation of interest, dividends, and capital
gains at the individual level, as well as depreciation and subsidies. Column 4 presents
the estimated rates for unincorporated business (proprietorships and partnerships). These
business tax rates reflect investments in equipment, structures, and inventory. Column
5 presents estimated tax rates for owner-occupied housing, which is normally close to
zero because of the exclusion of implicit net rent from income. Column 6 provides a
weighted economy-wide tax rate.
Congressional Research Service ˜ The Library of Congress

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CRS-2
Table 1: Marginal Effective Tax Rates on Capital Income
(percent)
Corporate
Corporate
Non-
Owner-
Year
U.S. Total
Firm-Level
Total
Corporate
Occupied
1953
63
70
37
-1
58
1954
50
57
23
-1
43
1955
51
58
24
-1
44
1956
53
60
25
-1
46
1957
55
61
27
-1
48
1958
55
61
26
1
47
1959
52
58
25
1
45
1960
49
55
23
1
42
1961
49
55
22
1
42
1962
42
48
17
1
35
1963
41
47
16
1
34
1964
38
44
14
0
31
1965
37
42
13
1
29
1966
37
42
14
1
30
1967
40
45
17
1
33
1968
44
50
20
3
37
1969
52
58
28
5
45
1970
48
54
26
5
42
1971
43
50
21
5
38
1972
44
51
21
5
38
1973
43
51
21
5
38
1974
48
55
25
7
42
1975
51
56
27
11
44
1976
46
53
23
7
40
1977
41
49
23
6
40
1978
50
58
26
10
46
1979
47
57
29
11
45

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CRS-3
Corporate
Corporate
Non-
Owner-
Year
U.S. Total
Firm-Level
Total
Corporate
Occupied
1980
51
60
33
15
48
1981
37
48
24
12
38
1982
35
43
22
9
35
1983
39
46
20
8
34
1984
38
44
20
7
33
1985
38
44
20
7
33
1986
38
45
19
6
33
1987
35
44
22
4
33
1988
35
43
22
4
33
1989
34
43
22
4
33
1990
33
42
22
3
31
1991
32
41
22
3
30
1992
32
41
22
3
30
1993
33
42
22
2
31
1994
32
41
22
2
30
1995
32
42
22
2
31
1996
32
42
22
2
31
1997
31
41
23
2
31
1998
31
41
22
2
30
1999
30
40
23
2
30
2000
31
41
23
2
31
2001
32
41
22
2
30
2002
30
39
21
2
29
2003
27
32
18
2
23
Source: See text for method of calculation.
As shown in Table 1, tax rates for business investment fell from the early 1950s to
the mid-1960s, reflecting more accelerated depreciation, investment credits, and lower
statutory tax rates. Rates rose towards the end of the 1960s with the repeal of the
investment credit, which was restored in 1971 and led to lower rates. Rates then began
to rise in the mid-1970s as inflation resulted in a smaller value of depreciation deductions

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CRS-4
by firms; inflation also caused the penalty for not deducting mortgage interest for non-
itemizers to become more severe. Increases in depreciation and lower rates adopted in
1981, which were followed by more restrictive depreciation but lower corporate and
individual rates in 1986 and slowing inflation, led to lower tax rates in the 1980s and
1990s. The most recent reductions in tax rates arose from the lower tax rates adopted in
the 2001-2003 legislation, the adoption of bonus depreciation in 2002 which was
expanded in 2003, and the lower rates on dividends and capital gains adopted in 2003.
These changes, which are currently temporary, result in a historically low tax rate.1
The tax rates in Table 1 do not account for the tax benefits to investments through
pensions and individual retirement accounts (where tax rates are generally effectively
zero); about half of passive income (interest, dividends, and capital gains on stock) is
received in tax exempt form. These provisions affect marginal tax rates only if they affect
the return to the marginal saving decision. Many investments in these forms are made up
to the maximum contribution limit, many pension plans are not under individual control,
and even where investments are not at the limit all marginal investments may still not
flow through the tax-favored account. All of these factors suggest not including these tax
benefits in marginal calculations. However, there is probably some marginal effect, and
if the individual income tax rate on these passive forms of income is set to one half of its
value to reflect the share of non-taxed investment returns, tax rates would be reduced
substantially — in recent years by about 8 percentage points without the lower rates
(particularly on dividends and capital gains) enacted recently; about six percentage points
for 2003.2
Methodology for Calculating Effective Tax Rates
The basic formula for calculating the effective tax rate is (r − R) / r , where r is the
pre-tax return, or internal discount rate for an investment with no taxes, and R is the after-
tax discount rate that discounts all flows to the cost of the investment with taxes.
For a business depreciable investment, the relationship between r and R, with R the
firm’s discount rate, derived from an investment with geometric depreciation and
continuous time, is the standard formula:
(1) r = ( R + δ )(1 − uz − k(1 − auz)) / (1 − u) − δ
where u is the firm’s statutory tax rate (either the individual or corporate rate), δ is the
economic depreciation rate, z is the present discounted value of depreciation deductions,
k is the investment tax credit, and a is a determinant of the basis adjustment, set at one,
0.5, and zero if there is a full basis adjustment (i.e. depreciation allowed only on cost net
of the credit), half basis adjustment, or no basis adjustment respectively.
1 For a more detailed discussion of the recent tax revisions, see CRS Report RL32099, Capital
Income Tax Revisions and Effective Tax Rates, by Jane G. Gravelle.
2 See discussion in CRS Report RL32099.

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CRS-5
The formula in (1) is applied to obtain firm-level tax rates (the firm-level corporate
rate in column 2 and the non-corporate rate in column 4), with R a weighted average of
the after-tax real interest rate (i(1 − u) − π) where i is the interest rate and π is the
inflation rate and the required real return on equity before individual tax. Debt is
weighted one-third. In the case of total corporate tax rates in column 3, the pre-tax return
R is derived from equation (1) but is compared with the return after personal taxes to
individuals (the same discount rate used for non-corporate business), a weighted average
of the after-tax real return on debt (i(1 − t) − π ) , where t is the individual tax rate, and
the after-tax return on corporate equity (which is net of taxes on capital gains and
dividends). In the case of the firm level corporate tax rate in the second column of Table
1, R is the discount rate of the corporate firm (before personal level taxes).
The tax rate for owner-occupied housing omits the effect of depreciation and taxes
on profit — the pre tax return is simply R + f (1 − n)t − ntp , where f is the debt share,
n is the share of investments with individuals who itemize on their tax returns, p is the
property tax rate, and R is the after-tax discount rate. If all mortgage interest deductions
were allowed, but no property tax deductions, the tax rate would be zero because there is
no tax on the imputed net rent. A slight positive or negative tax may arise because of the
inability to deduct mortgage interest by non-itemizers and the ability to deduct property
taxes by itemizers.
The mathematical formulas and assumptions used to calculate tax rates, including
depreciation methods and lives, investment credits, inflation rates, and statutory tax rates,
as well as the tax rates themselves for 1953-1989, can be found in Jane G. Gravelle, The
Economic Effects of Taxing Capital Income, Cambridge: MIT Press, 1994, Appendix B,
pp. 287-301. The statutory tax rates, interest and inflation rates for 1953-1989 are in Table
2.1, p. 20.3
Tax rates for 1990-2003 incorporate a number of assumptions and tax law changes.
These include the increase in the tax life for structures from 31.5 to 39 years in 1993, the
lowering of the capital gains tax rate to 20% in 1997, the introduction of bonus
depreciation (expensing of a share of investment) at 30% for 2002 and 50% for 2003, and
the reduction in the tax rate for capital gains and dividends from 20% and the regular tax
rate respectively to 15%. Individual and corporate statutory tax rates and inflation and
interest rates are reported in Table 2 for 1990-2003. The pattern of change in individual
tax rates is based on the rate reported for the NBER simulation model, which can be
found at [http://www.nber.org/~taxsim/mrates/mrates3.html], visited December 15, 2003.
Tax rates are assumed to continue at the current year’s rate; slightly lower rates would
occur for 2001 and 2002 if the permanent long term rates enacted in 2001 were assumed,
although rates might also rise due to real bracket creep as well. Inflation rates are a 1/3
weight of the prior year and a two-thirds weight of the current year. The interest rate is
the Baa Bond rate.
3 Note that this table inadvertently reports the values for 1959, in the row for 1960, and omits
the 1960 values of 28, 52, 2.0, and 5.2 for the individual tax rate, corporate tax rate, inflation rate
and interest rate.

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CRS-6
Table 2: Tax, Inflation, and Interest Rates Used to Calculate
1990-2003 Tax Rates in Table 1
(percent)
Individual Tax
Corporate Tax
Year
Inflation Rate
Interest Rate
Rate
Rate
1990
23
34
4.2
10.3
1991
23
34
4.1
9.8
1992
23
34
3.2
9.0
1993
24
35
2.7
7.9
1994
24
35
2.4
8.6
1995
25
35
2.4
8.2
1996
25
35
2.3
8.0
1997
26
35
1.9
7.9
1998
26
35
1.4
7.2
1999
27
35
1.5
7.9
2000
26
35
1.9
8.4
2001
25
35
2.3
8.0
2002
25
35
1.8
7.8
2003
24
35
1.6
6.8
Source: See text.

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