CRS Updates Report on Historical Tax Rates on Capital Gains

Table 1 shows the estimated tax rates from 1953 to 2005. 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.

      Table 1. Marginal Effective Tax Rates on Capital Income

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 -- by about eight percentage points without the lower rates (particularly on dividends and capital gains) enacted recently; about six percentage points otherwise.²

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:

 

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 where I is the interest rate and 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 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 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 1990-2005 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 2004, 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 1990-2005. 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 November 20, 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.

     Table 2. Tax, Inflation, and Interest Rates Used to Calculate

² See discussion in CRS Report RL32099.

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.