Congressional Budget Office

Background Paper

the congress of the united states

Computing Effective Tax Rates on

Capital Income

December 2006
Pub. No. 2624
The Congress of the United States O Congressional Budget Office

CBO

Computing Effective Tax Rates on

Capital Income

December 2006
Notes

Sample equations and sums of numbers in the text and tables of this report may not equal 

totals because of rounding.
Preface

This CBO background paper explains and documents the effective tax rate calculations presented in the October 2005 CBO paper Taxing Capital Income: Effective Rates 

and Approaches to Reform. It begins by presenting the formulas used to compute effective tax rates and then describes the data used to implement the formulas. An appendix provides a user’s guide to an Excel workbook that can be used to compute the 

effective tax rates in Taxing Capital Income.

Larry Ozanne and Paul Burnham of CBO’s Tax Analysis Division wrote the paper 

under the direction of Roberton Williams and G. Thomas Woodward. Robert Dennis 

and Arlene Holen provided useful comments and assistance.

Kate Kelly edited the manuscript and Christine Bogusz proofread it. Denise JordanWilliams assisted with formatting the report. Maureen Costantino and Alan Keaton 

prepared the report for publication, Lenny Skutnik produced the printed copies, and 

Simone Thomas prepared the electronic version for CBO’s Web site (www.cbo.gov). 

Donald B. Marron

Acting Director

December 2006

v

Contents

Introduction 1

Methodology for Computing Effective Tax Rates 1

Defining Effective Tax Rates 1

Basic Formulas 2

Refinement of the Basic Formulas 11

Measuring the Uniformity of Effective Tax Rates 25

Implementation of Effective Tax Rate Calculations 28

Identifying and Taxing Marginal Investments 28

Identifying and Taxing Marginal Saving 49

Specifying Economic Depreciation Rates and Tax Depreciation 

Allowances 66

Specifying Rates of Return 72

Appendix: User’s Guide to the Effective Tax Rates Workbook 77

Tables

1. Tax Depreciation Schedules for $1 Invested in an 

Asset with Five-Year Recovery 15

2. Aggregations of Effective Tax Rates 26

3. Allocation of Assets Among Forms of

Organization and Tax Treatment Categories,

by Minor Industry 38

4. Allocation of Assets Among Tax Treatments for 

Corporations and Sole Proprietorships, 

by Minor Industry 42

5. Allocation of Assets Among Tax Treatments for 

Partnerships, by Major Industry 45

6. Corporate Equity Held by Households and

Nonprofits, 2002 52

7. Credit Instruments Held by Households and

Nonprofits, 2002 54
vi

8. Nonprofit Share of Assets and Liabilities, 2000 56

9. Nonprofit Assets and Household Assets 

Distributed by Entity-Level Tax Treatment 57

10. Distribution of Credit Market Instruments and

Corporate Equities Outstanding, 

by Entity-Level Tax Treatment, 2002 59

11. Assets Held by Households, by Individual-Level

Tax Treatment, 2002 61

12. Distribution of Assets and Percentage of Marginal 

Saving Exempted or Deferred 63

13. Distribution of Marginal Saving for Families 

Constrained and Unconstrained by 

Contribution Limits 64

14. Parameters Affecting the Taxation of Capital Gains 65

15. Economic Depreciation Rates and Tax Depreciation

Parameters 66

16. Present Values of Economic Depreciation and 

Tax Depreciation of Corporate Assets 72

17. Real Rates of Return and Rate of Inflation 74

A-1. Worksheet Summary: Full detail 80

A-2. Parameters Summary, Sources of Marginal Saving 86

A-3. Residential Capital Stock: Amounts and Tax

Treatment 91

A-4. TxDeprMthd Worksheet Locations of Values

Associated with Declining-Balance Depreciation 93

A-5. TxDeprMethd Worksheet Locations of Values 

Associated with Straight-Line Depreciation 94

A-6. TxDeprMthd Worksheet Locations of Values

Associated with Annual Recovery Percentage

Depreciation 95

A-7. Aggregated Rates of Return to Savers 98

Tables (Continued)
vii

Figures

1. Remaining Value for $1 Invested in an Asset with 

Five-Year Recovery Under Straight-Line 

Depreciation 14

2. Remaining Value for $1 Invested in an Asset with 

Five-Year Recovery Under the DoubleDeclining-Balance Method with and without a 

Switch to Straight-Line Depreciation 16

Boxes

1. What Is “Corporate”? What Is “Noncorporate”? 29

2. Aggregated Industries Used in Spreadsheet

Calculations 31

3. Sources of Tax Data Used to Supplement 

Bureau of Economic Analysis Data 34

1

Introduction

In its October 2005 paper, Taxing Capital Income: Effective Rates and Approaches to 

Reform, the Congressional Budget Office (CBO) used the framework of effective tax 

rates to determine how heavily and uniformly the federal government taxes capital 

income and how that taxation would be affected under several scenarios for reform. 

The effective tax rates computed in that paper were built on methods developed for 

earlier studies; this background paper documents CBO’s application of those methods.1 The first section presents the methodology used to compute effective tax rates; 

the second section describes the data used to implement the methodology. The 

appendix is a user’s guide to an Excel workbook of spreadsheets for computing the 

effective tax rates in the paper.2

Methodology for Computing Effective Tax Rates

Although the concept of effective tax rates is straightforward, tax law makes their 

actual computation complicated. After explaining the concept, this section lays out 

the basic formulas and then develops several refinements. It ends by describing how 

effective tax rates for different assets were combined and compared in Taxing Capital 

Income.

Defining Effective Tax Rates

An effective tax rate on capital income measures the bite that taxes take out of the 

return earned by an investment. For example, if an investment in a new factory earned 

a 6 percent return and taxes took 2 percentage points of that return, 4 percentage 

points would be left for the savers who provided the capital. The 2 percentage points 

taken in taxes is called the tax wedge; the tax rate is the ratio of the wedge to the 

before-tax return—in this case, one-third.3

An effective tax rate and a statutory tax rate differ in several ways. An effective tax rate 

applies to the economic income earned over the life of an investment, so it accounts 

1. Don Fullerton and Yolanda Kodrzycki Henderson, “Incentive Effects of Taxes on Income from 

Capital: Alternative Policies in the 1980s,” in Charles R. Hulten and Isabel V. Sawhill, eds., The 

Legacy of Reaganomics (Washington, D.C.: Urban Institute Press, 1984), pp. 45–89; Don Fullerton, 

Robert Gillette, and James Mackie, “Investment Incentives Under the Tax Reform Act of 1986,” in 

Compendium of Tax Research 1987 (Department of the Treasury, Office of Tax Analysis), pp. 131–

172; Jane G. Gravelle, The Economic Effects of Taxing Capital Income (Cambridge, Mass.: MIT 

Press, 1994); Mervyn A. King and Don Fullerton, The Taxation of Capital Income (Chicago: University of Chicago Press, 1984); James B. Mackie III, “Unfinished Business of the Tax Reform Act 

of 1986: An Effective Tax Rate Analysis of Current Issues in the Taxation of Capital Income,” 

National Tax Journal, vol. 55, no. 2 (June 2002), pp. 293–338.

2. The workbook is posted along with this background paper at www.cbo.gov. The original workbook 

is labeled “effective tax rates.xls.” Also available is the revised workbook, “corrected ETRs.xls,” 

which corrects minor errors described in footnotes 22, 36, and 49 of this background paper.

3. More specifically, the ratio of the tax wedge to the before-tax return is the rate measured on a 

tax-inclusive basis.
2

for several factors beyond a single statutory tax rate: inflation, differences between tax 

depreciation allowances and economic depreciation, differences in taxation of returns 

on investment financed by debt or equity, and differences in taxation arising from 

how individuals hold their savings (in a bank account or pension fund, for example). 

An effective tax rate is a constant rate that, if applied to the return on an investment 

over its lifetime, would yield the same after-tax rate of return that would be yielded by 

application of statutory rates to all forms of taxable income in every year of the investment’s life.

Effective tax rates apply to a prospective investment that is assumed to just break even. 

That is, the cost of the investment would equal the present value of the return the 

business would have to pay to marginal purchasers of debt and equity after taxes were 

paid on the profits. Such tax rates are an important consideration in a business’s 

decision to invest because businesses tend to invest in the most profitable project first 

and to continue their investment in others in declining order of profitability until 

they reach the break-even or marginal project. Projects after that would not be undertaken. Therefore, changes in effective tax rates can change how many projects are 

undertaken.

Just as the business investments considered here are those that are marginal, so too are 

the sources of saving new or marginal. The tax rates savers pay on marginal savings 

can differ from those paid on existing savings. Consider an individual who has saved 

up to the limit in an individual retirement account (IRA). The investment earnings of 

the account are not taxable, but if the person saved one dollar more, it could not be 

deposited into the account, and the investment returns on that dollar would be taxed.

Effective tax rates are computed by specifying two rates of return on an investment. 

One is the real (inflation-adjusted) rate of return that a marginal investment must 

earn before taxes to recover its investment, to pay savers their return, and to pay taxes 

on the business. The other is a real rate of return savers expect to receive after taxes on 

the marginal savings provided to a business. The difference between those two rates of 

return is the tax wedge; the ratio of the tax wedge to the before-tax rate of return is the 

effective tax rate, ETR, expressed algebraically as

where before and after are the before- and after-tax returns on investing. 

Basic Formulas

Marginal investments made in corporations, noncorporate businesses, and owneroccupied housing are assumed to satisfy similar break-even conditions. Because the 

ways taxes are levied on the investment returns are substantially different, however, 

the expressions for the before- and after-tax returns developed for corporations must 

(1)

before

before after ETR − =
3

be modified to illustrate the case for noncorporate businesses and for owner-occupied 

housing. The corporate case is given first.

Corporate Before-Tax Rate of Return. The before-tax return required for a marginal 

investment by a corporation can be expressed as follows: 4

where

ρ is the real before-tax return a corporation requires on the marginal investment,

r is the nominal discount rate of the corporation,

π is the rate of inflation,

δ is the rate of economic depreciation of the investment,

u is the statutory corporate tax rate on the marginal investment,

z is the present value of tax depreciation allowances per dollar of investment, and

w is the property tax rate.

The subscript c distinguishes the parameter values that apply to corporations from 

those that will be applied to noncorporate businesses, n, and owner-occupied housing, 

h.

The present value of tax depreciation allowances per dollar of investment, z, is derived 

from expressions of the following form:

where

Y is the number of years over which the asset can be depreciated for tax purposes,

y is time in years, and

4. See, for example, Fullerton and Henderson, “Incentive Effects of Taxes,” pp. 84–85. Their parameters a and k, which represent the investment tax credit, have been omitted from equation (2) 

because the tax laws and proposals considered in Taxing Capital Income omit the investment tax 

credit. Similar specifications are used by the other studies cited in footnote 1.

 (2)

(3)

− + − δ −

− π + δ = ρ = uz w

u

r before c

c

c (1 ) 1

( )

z z y e dy

Y rcy

c − = 0

( )
4

z(y) is the tax depreciation schedule (specified later in the section “Refinement of the 

Basic Formulas”), and

e is the mathematical constant.

The nominal discount rate of the corporation, rc, is the cost of funds to the firm. If 

the firm obtains its funds as equity—whether from retained earnings or from new 

share issues—the firm must pay a real rate of return, Ec, that is comparable to what 

savers could earn on equity investments in other corporations. If the firm obtains its 

funds by issuing bonds or through borrowing, it must pay savers the nominal market 

interest rate, i. However, the firm can deduct its interest payments, leaving a net cost 

of i(1 – u). In the general case in which the firm finances its investments with a mix of 

debt and equity, the weighted-average nominal discount rate is

where fc is the fraction of the investment financed by debt. The real discount rate,

rc – π, which appears in equation (2), becomes

The value of fc can vary from zero, which represents all-equity financing, to one, 

which represents all-debt financing. Varying the value of fc directly affects the value of 

rc in equation (4), and it indirectly affects the value of zc in equation (3); both flow 

through to affect the value of ρc in equation (2).

Corporate After-Tax Rate of Return. Sometimes an after-tax rate of return is specified 

as the return the corporation pays out after its tax. Combining that return with the 

before-tax rate of return generates the effective corporate income tax rate, ETR. Other 

times, an after-tax rate of return is specified as the return savers realize after they pay 

their personal income taxes. Using such an after-tax rate of return generates a combined corporate and individual effective tax rate—the effective total tax rate, ETTR.

Although only the ETTR is reported in Taxing Capital Income, researchers use both, 

and the Excel spreadsheets that accompany this background paper compute both. 

This paper uses ETTR to refer only to the combined tax on corporate investments; 

ETR refers to single layers of tax or taxes on all types of investment, as in equation (1).

After-Corporate-Tax Return and Effective Corporate Tax Rate. The real after-tax return 

paid by the corporation, rc' – π, is i – π on debt-financed investments and Ec on 

equity-financed investments. As a result.

,

where the prime distinguishes the after-tax return from the discount rate. The 

effective corporate tax rate can then be expressed as

(4)

(5)

(6)

= [ ] (1− ) + (1− )( + π) c c c Ec r f i u f

[ ] c Ec r f i u f c c − π = (1− ) − π + (1− )

c c c Ec after = r' − π = f (i − π) + (1 − f )
5

Important features of the corporate ETR can be illustrated with equations (2), (5), 

(6), and (7), and because those features concern the corporate tax, the property tax 

rate is ignored.

First, suppose an investment is financed entirely with equity, such that fc = 0, and the 

real after-tax return, rc' – π, and the corporation’s real discount rate, rc – π, equal Ec.

Then, if tax depreciation allowances equal economic depreciation—as specified later 

by equation (40)—the ETR equals u, the statutory corporate tax rate. Essentially, taxable income from equity-financed investments is the same as economic income, so the 

statutory rate equals the effective rate. That equality is a condition of a pure corporate 

income tax. In contrast, if the equity-financed investment is expensed so that zc = 1, 

the ETR becomes zero even though the statutory rate remains at u. That is a condition 

of a pure consumption tax. The effective tax rate is zero because the value of expensing at the time of the investment equals the present value of the taxes paid on the taxable income over the life of the investment.

Second, suppose an investment is financed entirely with debt, such that fc = 1, and the 

real after-tax return is greater than the real discount rate by the amount of the firm’s 

interest deduction. Then, if inflation is absent and tax depreciation allowances equal 

economic depreciation, ETR = 0. That is another condition of a pure income tax. If 

inflation is positive, however, the ETR becomes negative. The firm would benefit 

from being able to deduct the inflation premium in the interest rate, and it would 

increase investment until its before-tax return was less than its after-tax return. Accelerating tax depreciation relative to economic depreciation would encourage the firm 

to increase investment further, pushing the ETR further below zero. The ETR reaches 

a maximum negative value when investment is fully expensed. If the interest deduction is repealed, however, the ETR for debt-financed investments can be kept at zero 

when the investment is expensed. That is the reason proposals to allow full expensing 

typically are combined with proposals to repeal the deduction for interest expenses. 

Consumption tax proposals, for example, combine expensing and repeal of the interest deduction.

In an early paper on effective tax rates, Alan Auerbach set the after-tax return equal to 

the corporation’s discount rate, rc − π, even when debt finance was included.5 Computing the ETR with that specification does not allow the corporation’s deduction of 

interest to affect its effective tax rate, and therefore the ETR is positive.

(7)

5. Alan Auerbach, “Corporate Taxation in the United States,” Brookings Papers on Economic Activity,

no. 2 (1983), pp. 462–464. The method also was discussed by Mackie in “Unfinished Business,” 

pp. 295–296.

c

c c r ETR

ρ

ρ − − π = ( ' )
6

Individual After-Tax Return and Effective Total Tax Rate. The calculation of the ETTR

on corporate investment uses the after-tax return received by individuals rather than 

the return paid by corporations. In modeling individual taxes, CBO assumes that the 

marginal dollar of saving comes from three types of accounts that differ in the way 

their investment returns are taxed: fully taxable accounts, such as directly held corporate stocks and bonds, or savings accounts; temporarily deferred accounts, such as 

annuities and whole-life insurance policies; and nontaxable accounts, such as pension 

funds.6 The distribution of marginal saving among them is described in the next section. Mervyn King and Don Fullerton used similar categories of accounts; some other 

analysts either omit temporarily deferred accounts or use only fully taxable accounts 

for their computations.7

Consider first marginal saving that is invested in debt instruments either directly (for 

example, in corporate bonds), or indirectly (as a deposit in a savings account, for 

example). To the extent that marginal saving comes from fully taxable accounts, the 

individual’s real after-tax return is i(1 − tint) – π, where tint is the tax rate on interest 

received by marginal savers. To the extent that marginal saving comes from nontaxable accounts, the real after-tax return equals the real return paid by corporations, 

i − π. Finally, to the extent that marginal saving comes from temporarily deferred 

accounts, the saver’s real after-tax return, sc,d,td, is higher than it is on a fully taxable 

account, although it is lower than that on a nontaxable account (see the specification 

in “Refinement of the Basic Formulas”). Equation (8) is the result of combining the 

three types of accounts for the real after-tax rate of return of savers on corporate debt, 

sc,d

where

αc,d,ft is the share of marginal saving coming from fully taxable accounts,

αc,d,td is the share of marginal saving coming from temporarily deferred accounts, and

αc,d,nt is the share of marginal saving coming from nontaxable accounts.

6. The taxation of pension benefits upon withdrawal offsets the forgone taxes associated with deducting the amount originally contributed. It does not offset forgone taxes associated with the exemption for investment income, so the investment income can be characterized as nontaxable.

7. King and Fullerton, The Taxation of Capital Income, pp. 220–234, focus more on the unique taxation of life insurance companies than on the benefits of deferral for policyholders. For an example 

in which effective tax rates reflect only taxable accounts or only taxable and untaxed accounts, see 

Jane G. Gravelle, Capital Income Tax Revisions and Effective Tax Rates, CRS Report for Congress 

RL32099 (Congressional Research Service, January 5, 2005), pp. 5–11.

[ ] (1 ) ( ) (8) sc,d = αc,d,ft × i − tint − π + αc,d,td × sc,d,td + αc,d,nt × i − π
7

The after-tax return on equity is complicated by two additional considerations. First, 

savers receive returns from investing in corporate equities as dividends or as capital 

gains, the taxation of which differs. Second, it is not clear how much taxes on dividends or on capital gains contribute to the marginal tax burden on savers—there are 

two views on the subject. The “old view” is that because taxes on all dividends reduce 

after-tax returns, the contribution of the tax on dividends to the overall tax on equity 

is proportional to the amount of dividends paid. The “new view” is that only the taxes 

paid on dividends from new share issues reduce marginal returns to savers. Investment 

funded through reinvestment of earnings, in this view, has its return reduced only by 

the capital gains tax because that is the only additional tax paid if profits are reinvested 

rather than paid out as they are earned. In keeping with the assumptions in Taxing 

Capital Income, the development of the effective tax rate on equity here relies on the 

old view of dividends.8

As with the return on debt, return on equity can accrue in fully taxable accounts, in 

temporarily deferred accounts, and in nontaxable accounts. The after-tax return 

received on fully taxable stocks, sc,e,ft, is expressed as follows:

where

m is the share of the real equity return retained by the firm and reinvested,

(1 − m)Ec is the real equity return paid as dividends,

tdiv is the tax rate on dividends of marginal equity investors, and

g is the real return on retained earnings after the capital gains tax is paid by the 

marginal investor.

The after-tax return on retained earnings, g, reflects several factors that are unique to 

capital gains in fully taxable accounts: the deferral of tax on real and inflationary 

capital gains until the underlying asset is sold, the different statutory tax rates for 

short- and long-term gains, and the forgiveness of tax on gains held until death (see 

the specification in “Refinement of the Basic Formulas”).

The after-tax return on stocks held in temporarily deferred accounts, sc,e,td, is similar 

to that for debt and is also specified in “Refinement of the Basic Formulas.” The aftertax return on equity held in nontaxable accounts equals Ec. Thus, sc,e, the after-tax 

return to savers from corporate equity, can be evaluated as follows:

8. Congressional Budget Office, Taxing Capital Income, Appendix B, provides a more detailed 

description of the old and new views and quantitatively compares those views under selected 

scenarios.

g (9) s m E t c,e,ft = (1− ) c (1− div ) +
8

where

αc,e,ft is the share of marginal saving that comes from fully taxable accounts,

αc,e,td is the share of marginal saving from temporarily deferred accounts, and

αc,e,nt is the share of marginal saving from nontaxable accounts.

Combining the after-tax returns on debt and equity from equations (8) and (10) 

yields sc, the overall after-tax return to savers on corporate investment:

Finally, the effective total tax rate for an investment in the corporate sector is 

computed as follows:

Noncorporate Sector. In Taxing Capital Income, CBO calls businesses that are not 

subject to the corporate income tax “noncorporate businesses.” That designation 

includes sole proprietorships, partnerships (except to the extent that the partners are 

themselves subject to the corporate income tax), and, despite the “noncorporate” 

moniker, S corporations. Noncorporate businesses are typically smaller than are publicly traded C corporations, and their suppliers of equity savings, the business owners, 

typically manage the businesses. The profits of noncorporate businesses are passed 

back to the owners where they are subject to the individual income tax.

Even though taxes on the profits of noncorporate businesses are paid through the 

individual income tax, the tax code computes them similarly to taxes under the corporate income tax. Their impact, therefore, on the decision of business managers to 

invest in equipment and structures is similar to the impact of corporate income taxes. 

For that reason, the literature on effective tax rates models taxes on noncorporate 

businesses similarly to those on C corporations. In particular, the before-tax return 

that noncorporate businesses must earn on a marginal investment is expressed as 

follows:9

(10)

(11)

(12)

9. See, for example, Fullerton and Henderson, “Incentive Effects of Taxes,” pp. 84–85. In equation 

(13), as in equation (2), CBO sets Fullerton’s and Henderson’s parameter k to zero and their a to 

unity to remove the investment tax credit.

c,e c e ft c,e,ft c e td c e td c e nt Ec s = α , , ×s + α , , ×s , , + α , , ×

c c c d c c e s f s f s , , = + (1− )

c

c c s ETTR

ρ

ρ − =
9

Equation (13) is similar to equation (2)—the before-tax return for corporations—

except that tn, the tax rate on profits of noncorporate businesses, replaces u, the corporate tax rate. Tax depreciation allowances are based on the same schedule used for the 

corporate sector, but zn, the present value of those allowances, is computed with rn,

the nominal discount rate of the noncorporate firm, and therefore differs from zc, the 

present value of corporate allowances.

The real discount rate of the noncorporate firm under mixed debt and equity funding 

is as follows:

The terms in equation (14) parallel those used in equation (5) to describe the corporate discount rate. In CBO’s computations, fn, the share of the marginal investment 

financed by debt, differs from that in the corporate sector, as does En, the return paid 

on equity.

Because there is no second level of tax on the profits of a noncorporate business, the 

after-tax return on equity to savers, sn,e, equals En, the return paid by the firm after it 

pays its tax.10 (In this case, the savers generally are the business managers.) Furthermore, those amounts are assumed to equal sc,e, the after-tax return to savers on corporate equity, because noncorporate business owners would shift their equity between 

their business and corporate equities until the marginal returns were equalized.

The after-tax return on noncorporate debt, sn,d, is computed similarly to the after-tax 

return in equation (8) for corporate debt:

The only difference is that αn,d,ft, αn,d,td, and αn,d,nt—the shares coming from fully 

taxable, temporarily deferred, and nontaxable accounts—differ from those in Equation (8). Previous analyses have not allowed those shares to differ among sectors.

Combining the after-tax returns on debt and equity yields sn, the overall after-tax 

return on noncorporate investment:

(13)

(14)

10. Owners cannot hold their equity in accounts that would avoid or defer the business tax on profits, 

whose tax rate is tn. Owners who sell business assets or the entire business may owe capital gains 

taxes, but those taxes are omitted from the effective tax rate calculation because of their complexity 

and uncertainty. Instead, investments are assumed to be held indefinitely.

(15)

( ) − + − δ −

− π + δ

ρ = t z w

t

r n n

n

n n 1

1

( )

[ ] ( ) n n n n En r − π = f i(1− t ) − π + 1− f

sn,d = αn,d,ft ×[ ] i( ) 1− tint − π + αn,d,td ×sc,d,td + αn,d,nt × ( ) i − π
10

Combining the before- and after-tax returns for noncorporate equity gives the effective tax rate, which is also the effective total tax rate, because there is only one layer of 

taxation. The term ETRn is used to indicate one layer of taxation:

Owner-Occupied-Housing Sector. The return on equity invested in owner-occupied 

homes is exempt from income tax. Mortgage interest and property taxes paid on first 

and second homes are deductible for owners who itemize, although homeowners cannot deduct depreciation.11

Those differences lead to differences (from those for businesses) in the equation for 

the before-tax return on investment in owner-occupied housing. The lack of taxation 

on the equity return causes the tax rate in equation (2) to be set to zero, and the 

disallowance of depreciation deductions sets the present value of those deductions to 

zero. The limitation on the deductibility of property taxes to those who itemize 

requires that a new term be added. The resulting equation for the before-tax return on 

the marginal investment in owner-occupied housing is as follows:12

where 

th is the tax rate faced by marginal investors in owner-occupied housing and 

λh is the fraction of property taxes those investors deduct.

The real homeowner discount rate, rh − π, is specified using a similar expression to 

that used for businesses:

The fraction of funding from debt, fh, need not be the same as those for the corporate 

or noncorporate sectors. For convenience, the fraction of mortgage interest that is 

deductible is assumed to equal λh, the fraction of property taxes that is deductible.

(16)

(17)

11. The amount of interest that can be deducted is limited to that on $1.1 million of debt undertaken 

to buy, build, or improve a primary residence and a second home.

12. Fullerton and Henderson, “Incentive Effects of Taxes,” pp. 84–85.

(18)

 (19)

( ) n n n d n n e s f s f s = , + 1− ,

n

n n n

s ETR

ρ

ρ − =

( ) h h h h ρ = r − π + w 1− λ t

[ ] ( ) ( ) h h h h h Eh r − π = f i 1− λ t − π + 1− f
11

Because there is no tax on the equity return, the amount owners receive after taxes, 

sh,e, equals Eh, the amount they earn on their investment. Furthermore, because 

homeowners could shift equity between home and corporate equity (or, when possible, to a noncorporate business), it is assumed that the return on the marginal dollar 

of equity invested in a home equals the after-tax return on equity invested in corporate stocks or in a noncorporate business, sh,e = sc,e = sn,e. Home equity generally is not 

subject to the capital gains tax, and no such tax is included in the computation of the 

effective tax rate.

In contrast to the homeowner who pays no tax on the return on equity, the saver who 

lends mortgage financing might pay tax on the associated interest, depending on the 

type of account from which the loan is made. The after-tax return on homeowner 

debt, sh,d, is calculated using an expression similar to that for the corporate and noncorporate sectors. The difference is that the shares of marginal saving coming from 

fully taxable (αh,d,ft), temporarily deferred (αh,d,td), and nontaxable (αh,d,nt) accounts 

are unique to those who lend to homeowners.

Combining after-tax returns on equity and debt invested in owner-occupied homes 

gives sh, the overall after-tax return:

From the before- and after-tax returns on the marginal investment in owner-occupied 

housing, the effective tax rate is calculated as follows:

Refinement of the Basic Formulas

Several terms in the above formulas require further development. The analysis focuses 

on federal taxes so other taxes are removed from the formulas where they are unnecessary. Furthermore, the present values of tax depreciation allowances, the after-tax 

return from capital gains, and the after-tax return from temporarily deferred accounts 

are specified. Finally, the basic equations for before-tax returns need to be modified to 

accommodate inventories and land.

Focus on Federal Taxes. The effective tax rates computed in Taxing Capital Income are 

for federal taxes. In equations (2), (13), and (18), therefore, payments of property 

taxes to local governments were removed by subtracting w, the property tax rate, from 

the expressions for the before-tax rate of return on investments by corporations, noncorporate businesses, and homeowners. For corporate and noncorporate businesses 

alike, that operation completely removes property taxes from the expressions. For 

(20)

(21)

(22)

sh,d = αh,d,ft ×[ ] i( ) 1− tint − π + αh,d,td × sc,d,td + αh,d,nt × ( ) i − π

( ) h h h d h h e s f s f s = , + 1− ,

h

h h

h

s ETR

ρ

ρ − =
12

homeowners, the term −wλhth represents the amount by which federal individual 

income tax rates are reduced by itemized deductions of property taxes.13 The equations are revised as follows:

In other studies, calculations of income tax rates often include federal and state tax 

rates.14 The corporate tax rate, for example, would consist of the following:

Equation (26) accounts for the deductibility of state and local corporate taxes from 

federal tax income. Here, as in Taxing Capital Income, tax rates are limited to federal 

taxes, so u should always be interpreted as ufederal.

15

Like property taxes, state corporate and individual income taxes do not affect the federal tax rate on the marginal business investment. Businesses must earn enough on 

that investment to pay the state income tax, then deduct that payment before determining federal taxable income. Unlike property taxes, state income taxes do not affect 

the federal income tax on the marginal investment in owner-occupied housing. The 

difference between state income taxes and state and local property taxes arises because 

the marginal investment in owner-occupied housing generates no additional state 

income tax, although it does generate additional property tax.

13. Businesses also can deduct property taxes, but for the marginal investment they must pass those 

taxes on to customers, thereby increasing the business’s taxable income and offsetting the tax 

deduction. Owner–occupants cannot pass along the cost of the property tax, so the deduction is 

not offset by additional taxable income.

(23)

(24)

(25)

14. See, for example, King and Fullerton, The Taxation of Capital Income; Fullerton and Henderson, 

“Incentive Effects of Taxes”; and Fullerton, Gillette, and Mackie, “Investment Incentives.”

(26)

15. The omission of state taxes allows the focus of the analysis to remain on incentives that can be 

affected by the federal government. However, it produces lower effective tax rates than prospective 

investors would actually face. Use of an average state rate would give an estimate of how much state 

taxes add overall, but it would not necessarily reflect the effective tax rates faced by any particular 

investment because of the variation in rates by state.

( )( ) − − δ −

− π + δ

ρ = c c c uz

u

r 1

1

( )( ) − − δ −

− π + δ

ρ = n n

n

n n t z

t

r 1

1

h h h h ρ = r − π − wλ t

( ) u = ufederal 1− ustate + ustate
13

Present Values of Tax Depreciation Allowances. Because the tax code specifies two 

basic methods of depreciation, CBO uses two formulas to compute the present value 

of tax depreciation allowances: one for straight-line depreciation and the other for 

declining-balance depreciation with a switch to straight line. The second is used for 

the 200 percent and 150 percent declining-balance variations permitted by the tax 

code.

CBO uses three additional formulas to compute present values of depreciation allowances that would be permitted under proposed changes in the tax law: depreciation at 

a constant rate, economic depreciation, and expensing. In principle, expensing can be 

applied to the full investment, but between 2001 and 2004 it was permitted for a fraction of investment in some assets.

CBO’s formulas for current law are continuous-time analogues to the depreciation 

schedules provided by the Internal Revenue Service (IRS).16 The advantage of their 

use for calculation of effective tax rates is that they match the earnings streams from 

the continuous-time formulations of the before- and after-tax returns on investments 

specified above. The work cited in footnote 1 used continuous-time analogues for the 

same reason; CBO’s analogues most closely follow Jane Gravelle’s.

Straight-Line Depreciation. This method allows a constant-dollar amount to be 

claimed annually that will exhaust the purchase price of an asset over an allowed 

recovery period. Consider an asset purchased for $1 and allowed a five-year recovery 

period. Depreciation under the straight-line method would be 20 cents per year, and 

the undepreciated value of the asset would decline in a straight line from $1 to zero 

over five years (as shown in Figure 1). Of course, the market value of that asset could 

be more or less than its value for tax depreciation purposes.

More generally, the recovery period can be labeled Y years. The depreciated value of 

the asset declines in a straight line from $1 to zero between the date of purchase and Y. 

Depreciation is a constant amount per period 1/Y, which is the negative of the slope 

of the straight line. The present value of straight-line depreciation, zsl, is obtained by 

discounting those depreciation amounts at the nominal discount rate, r, of the firm 

making the investment. The present value can be written as shown in equation (27):

16. Department of the Treasury, Internal Revenue Service, Publication 946, How to Depreciate Property,

For Use in Preparing 2004 Returns, pp. 71–96.
14

Figure 1.

Remaining Value for $1 Invested in an Asset with Five-Year 

Recovery Under Straight-Line Depreciation

(Dollars)

Source: Congressional Budget Office. 

where y indexes the change in time from 0 to Y. Integrating the equation converts it to 

the formula used to compute present values:

From equation (28), one can verify that the present value of straight-line depreciation 

is lower when the recovery period is longer and when the discount rate is higher.

Declining-Balance Depreciation with a Switch to Straight-Line Depreciation. The 

combination of the declining-balance and straight-line methods creates additional 

complexity. The declining-balance method is actually a constant-percentage rate of 

depreciation, so the dollar amount of depreciation declines in each successive period. 

In the example of straight-line depreciation, $1 invested in an asset with a five-year 

recovery period can claim depreciation at the rate of 1/5, or 20 cents per year (see 

Table 1 for this and the examples that follow). The 200 percent declining-balance rate 

is 2/5, or 40 percent. So, for tax purposes, an investment of $1 would depreciate by 

40 cents in the first year. In the second year, depreciation would be 40 percent of the 

remaining value (60 cents), or 24 cents. At the end of the second year, the asset’s tax 

(27)

(28)

012345

0.0

0.2

0.4

0.6

0.8

1.0

1.2

Years

0

e dy Yz rY y

sl

−

= 0

1

rY

e

z

rY

sl

− − = 1
15

Table 1.

Tax Depreciation Schedules for $1 Invested in an 

Asset with Five-Year Recovery

(Dollars)

Source: Congressional Budget Office. 

value would be 36 cents. In the third year, its depreciation would be 40 percent of the 

36 cents of remaining value, or 14.4 cents. The declining amounts of depreciation 

under this method do not exhaust the value of the asset after five years: Just under 

8 cents of the initial $1 investment is unclaimed. In fact, the declining-balance 

method cannot completely depreciate the value to zero.

To allow taxpayers to fully recover investments when declining-balance depreciation is 

used, depreciation schedules switch to the straight-line method before the recovery 

period ends. The time chosen is the year in which straight-line depreciation on the 

remaining balance would give the same or a larger depreciation allowance. In the discrete time example described here, the switch would occur for the fourth year. At the 

end of the third year, the remaining depreciable value is 21.6 cents. The doubledeclining-balance method would allow about 8.6 cents of depreciation for the fourth 

year, but the straight-line method would allow 10.8 cents (half the remaining balance 

because the taxpayer has two more years to claim the 21.6 cents).

The continuous-time analogue is represented in Figure 2. The declining-balance 

method is shown by the curved line that starts at a value of $1 on the vertical axis at 

time 0. After five years, the undepreciated value is still positive. In the continuoustime analogue, the optimal time to switch to straight-line depreciation is at 2.5 years. 

From then through year five, the asset’s undepreciated value declines along a straight 

line to zero.

Year 0 1 1 1

1 0.2 0.8 0.400 0.600 0.400 0.600

2 0.2 0.6 0.240 0.360 0.240 0.360

3 0.2 0.4 0.144 0.216 0.144 0.216

4 0.2 0.2 0.086 0.130 0.108 0.108

5 0.2 0 0.052 0.078 0.108 0

Straight Line 

Remaining

Declining Balance 

 Depreciation Value Value Depreciation Value

200 Percent

200 Percent Declining Balance with

Depreciation

Remaining Remaining

Switch to Straight Line
16

Figure 2.

Remaining Value for $1 Invested in an Asset with Five-Year 

Recovery Under the Double-Declining-Balance Method with 

and without a Switch to Straight-Line Depreciation

(Dollars)

Source: Congressional Budget Office. 

Under the declining-balance method, the undepreciated value, V, of the asset at any 

time, y, is given by

where β, the rate of decline in value, is set by the acceleration of the straight-line rate 

of depreciation. That is, if acceleration is b times the straight-line rate, then β = b/Y. 

For a 200 percent declining balance over five years, β = 2/5, or 40 percent.

The slope, σdb, at time y implied by equation (29) is

and the slope converted to a positive amount is the depreciation allowance implied by 

the declining-balance method.

The point at which switching to straight-line depreciation will give the larger deduction can be determined by equating the depreciation rate in equation (30) to the slope 

of the straight line running from V(y) at that time to the value of zero at time Y, as 

shown in Figure 2. The slope, σsl, of that straight line is shown in equation (31):

(29)

(30)

0 0.5 1 1.5 2 2.5 3 3.5 4 4.5 5

0.0

0.2

0.4

0.6

0.8

1.0

1.2

Years

Double-Declining Balance

Straight Line

0

( ) y V y e−β =

y

db e

dy

dV −β σ = = −β
17

where Y* is the optimal switching time. It can be shown that

When the degree of acceleration is double the straight-line rate, the switching point is 

halfway through the recovery period, Y/2. When the degree of acceleration is 1.5, the 

switching point is one-third of the way through the recovery period, Y/3. Under the 

continuous-time analogue, the optimal switching time for double-declining-balance 

recovery over five years is 2.5 years, not three years as is the case for annual depreciation cited above.

The present value of depreciation deductions taken by the declining-balance method 

with a switch to straight-line depreciation at point Y* is given by

Integrating simplifies equation (33) to the formula CBO uses to compute present 

values:

Equations (28) and (34) make it possible to compute the present value of tax depreciation for the range of assets identified in the data set. For each asset, IRS Publication 

946 guides the taxpayer’s selection of a depreciation method, the degree of acceleration (if the method permits the declining-balance method), and the recovery period. 

Additional details are provided in the section on implementation.

Declining-Balance Depreciation. The President’s Advisory Panel on Federal Tax 

Reform proposed grouping all equipment and structures of a business into four categories and depreciating the remaining value of each category at a constant rate.17 That 

method is equivalent to the declining-balance method but without the switch to 

straight-line depreciation. The parameter β gives the constant rate of depreciation, 

but β is not necessarily determined by a particular recovery period and by a degree of 

(31)

(32)

(33)

(34)

17. President’s Advisory Panel on Federal Tax Reform, Simple, Fair, and Pro-Growth: Proposals to Fix 

America’s Tax System (November 2005), pp. 131–132. The depreciation proposal was to be part of a 

simplified income tax.

Y Y

e Y

sl − σ =

−β

*

*





 



 = − b

Y Y 1 * 1

( ) e dy Y Y

e

z e dy ry

Y Y

Y

Y r y

dbsl

− −β − β+

− = β + *

0 *

*

*

( ) [ ] ( ) [ ] rY rY

Y r Y

dbsl e e

Y Y r

e

e

r

z − − −β − β+ − − − +

β +

β = * * *

* 1
18

acceleration over straight-line depreciation. As with the declining-balance method, 

the rate is applied to the remainder of the original purchase price of the asset. Thus, 

the depreciation allowance at time y and per dollar of initial investment is given by 

equation (30). Although the balance of assets never reaches zero, the value many years 

into the future is small enough that a present value of depreciation allowances for an 

asset can be computed as follows:

which integrates to

Economic Depreciation. Economists have suggested setting tax depreciation equal to 

economic depreciation as a part of making taxable income equal to economic income. 

Economic depreciation—used in equations (23) and (24) to calibrate the before-tax 

rates of return—is assumed to occur at the constant rate δ. Examinations of actual 

depreciation rates show that many assets depreciate at an approximately constant 

rate.18 Thus, setting tax depreciation to economic depreciation in the framework 

developed above requires setting the parameter β in the declining-balance method to 

δ. However, an additional adjustment is required. Economic depreciation applies to 

the replacement value of the asset, which accounts for the effects of inflation on the 

asset’s value. The inflation-adjusted value at time y of $1 invested in an asset at time 

zero is expressed as

and economic depreciation at that time is

The present value of economic depreciation is given by

or

(35)

(36)

18. Charles R. Hulten and Frank C. Wycoff, “The Measurement of Economic Depreciation,” in 

Hulten, ed., Depreciation, Inflation, and the Taxation of Income from Capital (Washington, D.C.: 

Urban Institute Press), pp. 81–125.

(37)

(38)

(39)



∞ −β − = β 0

z e e dy y ry

db

r

zdb β +

β =

( )y V y e π−δ ( ) =

( )y z y econ e π−δ ( ) = δ

( ) 

∞ π−δ − = δ

0

z e e dy y ry

econ
19

If the expression on the right-hand side of equation (40) is substituted into 

equation (23) for the before-tax rate of return on corporate investment, the expression 

for the corporate ETR under equity finance simplifies to u. Thus, setting tax depreciation allowances to economic depreciation causes the effective tax rate to equal the statutory corporate tax rate, as discussed in the section on the corporate ETR. Setting tax 

depreciation equal to economic depreciation also causes the effective tax rate on 

equity-financed investment by noncorporate businesses to equal tn, the statutory tax 

rate on noncorporate business.

Expensing. The President’s panel and many economists have proposed allowing businesses to expense the full value of investments when they are made.19 When full 

expensing is allowed, the present value of the deduction is simply the cost of the 

investment, so z = 1. As discussed in the section on the corporate ETR, expensing, 

combined with the deductibility of business interest expenses, reduces the effective tax 

rate on debt-financed investments to below zero. Consequently, expensing is generally 

proposed as part of broader proposals for a consumed-income tax, which sets to zero 

the effective tax rate on the marginal investment of corporate and noncorporate 

businesses. Those proposals also include repeal of the deduction for interest expenses. 

Taxing Capital Income develops those points further.

In the Job Creation and Worker Assistance Act of 2002, partial expensing was allowed 

for some assets purchased and installed between 2001 and 2003. Businesses could 

expense 30 percent of a qualified investment and depreciate the remaining 70 percent 

under normal rules. The Jobs and Growth Tax Relief Reconciliation Act of 2003 

(JGTRRA) raised expensing to 50 percent and extended the period through 2004. If x

is the fraction expensed, the present value of depreciation for an asset under partial 

expensing, zpxp, is given by equation (41):

where z is the present value of depreciation for the asset under normal tax rules, as 

defined above.

Capital Gains Taxes. Computation of effective tax rates in this paper follows the common practice of assuming that corporations pay out some profit as dividends and 

retain the rest for investment in new assets. This paper does not consider the use of 

profits to repurchase shares or the realization of capital gains taxes by noncorporate 

businesses and homeowners.

(40)

19. President’s Advisory Panel on Federal Tax Reform, Simple, Fair, and Pro-Growth, pp. 163–164.

(41)

δ + − π

δ = r

zecon

zpxp = x + ( ) 1− x × z
20

Corporations that reinvest profits in marginal investments should raise the value of 

their shares by the amount invested. Over time, more earnings are reinvested and the 

value of the shares continues to rise. When shareholders sell the stock, they realize the 

accumulated return. At that time (and assuming the investment is taxable), the capital 

gains tax is levied on the nominal increase in the share price since the time the shareholder purchased it. The shareholder keeps the residual as the nominal after-tax 

return. That return is not suitable for inclusion as the term g in equation (9), however. 

To be included, it must be converted to a real annualized rate of return.

To make that conversion, consider the case of a saver who purchases one share of stock 

in a corporation at time 0 and holds it until time Y. The firm earns a real rate of 

return, E. It reinvests the fraction m and pays out the rest as dividends. The reinvested 

earnings raise the value of the company’s stock by the amount reinvested. In addition, 

the value of the stock is raised by the inflation rate, π. Assuming time is measured 

continuously, the value of the stock at the time it is sold can be expressed as

The capital gain on the stock is the difference, V(Y) −V(0), and it is taxed at the statutory rate on capital gains of tcg. The amount the saver has after payment of the tax, 

V(Y)', is

Substituting the right-hand side of equation (42) for V(Y) in the right-hand side of 

equation (43) gives

That after-tax return can be converted into an equivalent real annualized rate of 

return by solving for the term g in equation (45):

To solve for g, set the right-hand side of equation (45) equal to the right-hand side of 

equation (44), take the natural logarithm of both sides, and rearrange. The resulting 

expression for g is shown in equation (46) for short-term gains—those held for less 

than one year and taxed at the saver’s ordinary income tax rate, tscg.

For holding periods of more than one year, the realized capital gain is subject to tax at 

a reduced rate, tlcg, as shown in equation (47).

(42)

(43)

(44)

(45)

(46)

( ) () ( ) mE Y V Y V e π+ = 0

V( ) ( ) ( ) () Y '=V Y − tcg [ ] V Y −V 0

( ) ()( ) ( ) [ ] cg

mE Y

cg V Y =V − t e + t π+ ' 0 1

( ) () ( ) g Y V Y V e π+ ' = 0

( ) ( ) = × [ ] − + − π π+

scg

mE Yscg

scg

scg

scg t e t

Y g ln 1 1
21

Furthermore, if the stock is held until the owner dies, the gain accrued at that time is 

exempt from income tax, so the annualized return is simply the real accruing gain, 

mE.

The three annualized after-tax rates of return must be combined into a weighted average rate g, which is used in equation (9). The weights represent the share of the marginal dollar of saving in taxable stock investments that is held for less than one year, 

ωscg; the share held for more than one year but not until the owner’s death, ωlcg; and 

the share held until the owner’s death, ωxcg. The expression is

In Taxing Capital Income, CBO computed effective tax rates for the President’s proposal in 2003 to integrate corporate and individual income taxes. In addition to eliminating the tax on some dividends, the proposal would have altered the way owners 

of corporate stocks compute the capital gain when they sell their stock. The portion of 

retained earnings attributable to those stocks would be added to the initial purchase 

price, and that sum would be subtracted from the sale price to arrive at the taxable 

capital gain. That computation would lower the taxable gain and thus the tax, thereby 

raising the after-tax return on retained earnings relative to that in equation (47). The 

gain remaining to be taxed on the initial stock purchase and on the amounts reinvested would be attributable to inflation.

To reflect the proposal in the expressions above, the initial purchase price, V(0), in 

equation (43) would be supplemented by the amount of earnings retained from year 0 

to year Y. That sum would be subtracted from the sale price, V(Y). Cumulative 

retained earnings, κ, can be expressed as

When κ is incorporated into equation (43), and subsequent equations are adjusted to 

reflect that change, the expression for g in equation (47) is modified by replacing tlcg

with t'lcg, which is given by equation (50):

In essence, allowing retained earnings to be added to the purchase price in measuring 

taxable capital gains is equivalent to reducing the statutory tax rate on gains by the 

(47)

(48)

(49)

(50)

( ) ( ) = × [ ] − + − π π+

lcg

mE Ylcg

lcg

lcg

lcg t e t

Y g ln 1 1

g = ωscg × gscg + ωlcg × glcg + ωxcg × mE

( ) ( ) [ ]1 0 − π +

κ = π+mE Y e

mE

mEV

lcg lcg t

m

t

π +

π ' =
22

fraction π/(π + m) when computing the real after-tax return. A parallel adjustment is 

made in equation (46) for short-term capital gains.

Taxation of Annuities and Whole-Life Insurance. Savers use annuities to convert current payments into a future income stream (generally before the owner’s death). The 

amounts savers pay, called considerations, are invested and earn returns until paid out, 

and the returns are not taxed until that time. Taxes that normally would be paid as 

returns are earned, therefore, are instead deferred. That treatment is similar to the taxation of capital gains, which are not taxed until they are realized from the sale of an 

asset. Because of the similarity, the real annual rate of accrual from an investment in 

an annuity is given by an expression similar to that in equation (47). One difference 

between investing in an annuity and investing in a stock is that taxation of the entire 

return of the annuity is deferred until the payout. Stock dividends, in contrast, are 

taxed as they are earned. Another difference is that the annuity payout is taxed at 

ordinary rates instead of at the lower rates that apply to long-term capital gains and 

dividends.

Many annuities promise a fixed payout, which implies a fixed return over a period of 

years, and they tend to be invested in corporate bonds or in mortgages of noncorporate businesses. These annuities are assumed to earn the market interest rate, i.

When an investment is held in such an annuity for Ytd years and then paid out, the 

real annual rate of return is given by the following variant of equation (47):

Here s'c,d,td is the real after-tax return for temporarily deferred saving either in corporate bonds or in debt obligations of noncorporate businesses. Like interest income, 

the portion of the payout from an annuity that represents return of investment 

income is taxed as ordinary income. However, the tax rate that applies to annuity distributions, ttd, can differ from the tax rate that applies to interest income, tint, because 

the recipients of annuities can be in different tax brackets than are recipients of 

interest.

Whole-life insurance also is subject to deferred taxation. The initial premiums are 

larger than would be necessary to pay death benefits for people of the policyholder’s 

age, the excess is invested, and the earnings accumulate. The earnings then can be 

used to keep premiums from rising as the policyholder ages or for savings the policyholder can tap. As long as those earnings are used to pay premiums or death benefits, 

they are not taxed. In that case, the full return, i, is untaxed, and the real after-tax 

return is i − π. Whole-life insurance assets are largely invested in debt obligations. 

Thus, the return from investing in tax-deferred debt instruments is an average of the 

return on annuities and the return on the untaxed part of saving through whole-life 

insurance. That return, sc,d,td, is computed as follows:

(51) = [ ] ( ) − + td − π iYtd

td

td

c d td t e t

Y

s ln 1 1 ' , ,
23

where γ is the fraction paid out as untaxed insurance premiums or death benefits.

Some annuities are invested in corporate stocks rather than in debt obligations. The 

real after-tax return to savers using these annuities also is expressed by a variant of 

equation (47), but the real return is E rather than i − π. Like annuities invested in 

debt instruments, the eventual payout is taxed as ordinary income. CBO assumes that 

tax rate is the same as the rate on payouts from annuities invested in debt obligations. 

The real after-tax return from annuities invested in stocks, sc,e,td, is given by

The small amount of equity investment in whole-life insurance is ignored.

Inventories. Inventories can be inputs purchased for use in manufacturing, such as 

steel purchased by an automaker. Inventories also can be finished products held by the 

firm until they are sold, such as automobiles held by dealerships. In either case, the 

inventories are considered capital for the businesses that hold them. Inventories 

typically are held for much shorter periods than are other forms of capital, such as 

equipment and structures, that businesses purchase. Inventories are assumed not to 

depreciate in value, nor are their holders allowed to take depreciation allowances for 

determining taxable income. When inventories or the products made from them are 

sold, the cost of purchasing the inputs is deductible against the revenue from the sale.

The marginal investment in inventories by the profit-maximizing firm is assumed to 

cover the amount the firm must pay to savers whose funds are tied up in inventories 

and the taxes it must pay on the value of sales attributable to the inventories. More 

specifically, the corporation’s marginal investment of $1 held for Yv years must appreciate by enough to earn the amount needed to pay taxes on the increase in value and 

still leave enough to cover the firm’s cost of funds, r. When the cost of inventories for 

tax purposes is based on their cost at the time of purchase (called first-in, first-out or 

FIFO accounting), the following condition should hold:

When FIFO accounting is used, the growth rate for inventories’ value is the sum 

ρ + π, where ρ is the growth rate exclusive of inflation (or the real growth rate) and π

is the rate of inflation. The real growth rate is analogous to the real before-tax return 

in equation (2) for corporations. The expression can be solved for ρ for use in computing the effective tax rate on investment in inventories:

(52)

(53)

(54)

( )( ) c d td c d td s i s , , , , = γ − π + 1 − γ '

( ) ( ) = [ ] − + − π π+

td

E Ytd

td

td

c e td t e t

Y

s ln 1 1 , ,

() () = − ( −1) v ρ+π Yv ρ+π Yv rY e e u e
24

Tax law also allows firms to use the price of inventories at the time of sale through 

last-in, first-out (LIFO) accounting. In that case, the marginal investment in inventories should meet the following condition, which is a modification of equation (54):

The real before-tax return becomes

A weighted-average real before-tax return for a marginal dollar invested in inventories 

can be computed as follows:

where φ is the proportion of the marginal dollar invested in inventories that follow 

FIFO accounting.

The corporate ETTR is computed by combining this ρ with the real after-tax return 

of savers, as in equation (12). Real before-tax returns for noncorporate firms are computed with formulas analogous to those in equations (54) through (58), with only the 

tax rates and discount rates changed. Of course, the effective tax rates on inventories 

for noncorporate businesses are computed using the after-tax return on saving supplied to noncorporate businesses, as in equation (17).

Land. Effective tax rates for investments in land were computed in largely the same 

way as were rates for investments in equipment and structures. However, in the land 

computations, the economic depreciation rate was set to zero and no tax depreciation 

was included. 

Gravelle recommends that land be omitted from effective tax rates for the entire economy because land is in fixed supply for the U.S. economy, and no marginal investment could increase the quantity of land. For individual firms, industries, or even the 

corporate sector, she recommends land be included because each portion of the economy could expand its quantity of land by buying it from the remaining sectors. Others who compute effective tax rates include land for the entire economy as well as for

(55)

(56)

(57)

(58)

− π 















−

− ρ = u

e u

Y

1 v rY

v

FIFO 1

ln

() () ( ) v Yv Yv Yv rY e e u e e ρ+π ρ+π π = − −

( )

















−

− ρ =

−π

u

e u

Y

r Yv

v

LIFO 1

ln 1

( ) ρ = φρ FIFO + 1 − φ ρ LIFO
25

its components, and Taxing Capital Income follows that practice.20 One rationale for 

including land in computations for the entire economy is that it can be improved to 

become more useful through irrigation, drainage, grading, and so on.

Measuring the Uniformity of Effective Tax Rates

In Taxing Capital Income, CBO compared effective tax rates for the corporate and 

noncorporate sectors, for debt and equity financing, and for tenant-occupied and 

owner-occupied housing. To make those comparisons, CBO aggregated effective tax 

rates over several asset types and sources of saving. It also measured the uniformity of 

effective tax rates among different asset types, using an interquartile range.

Comparing Aggregate Effective Tax Rates. Most measures of uniformity that CBO 

used were based on weighted-average tax rates computed for six aggregations of possible investments. CBO also computed effective tax rates for aggregations of all business 

investments and all business and homeowner investments. Those reflected the overall 

level of capital taxation rather than the relative levels indicated by the six narrower 

aggregations. The aggregations and their components are listed in Table 2.

The aggregate tax rates were constructed by separately averaging before-tax returns 

and then after-tax returns for each aggregation and then constructing an aggregate 

effective tax rate from those averages using the definition of effective tax rates in equation (1). For example, consider the aggregate ETTR for marginal investment in the 

corporate sector. The average before-tax return, represented by ρc,all, is computed as

where

Bl

 is the capital stock of one of the 49 types of assets,

qc,l is the share of the stock of that asset type in the corporate sector, and

ρc,l is the before-tax return computed from equation (23) for that asset type.

20. Gravelle’s recommendations were delivered to CBO through personal communication. Others also 

include Fullerton and Henderson, “Incentive Effects of Taxes,” p. 51; Fullerton, Gillette, and 

Mackie, “Investment Incentives,” pp. 145–147; and Mackie, “Unfinished Business,” pp. 309–310.

(59)





=

=

ρ

ρ = 49

1

,

49

1

, ,

,

l

l c l

l

l c l c l

c all

B q

B q
26

Table 2.

Aggregations of Effective Tax Rates

Source: Congressional Budget Office.

Note: n.a. = not applicable.

a. Fully taxable, temporarily deferred, and nontaxable accounts.

Components

Aggregation Sectors Financing Mix Asset Types

Sources of 

Savinga

Corporate n.a. 41 percent debt, 

59 percent equity 

49 asset types 3 sources of 

saving for 

corporate 

sector

Corporate equity n.a. 100 percent equity 49 asset types 3 sources of 

saving for 

corporate 

sector

Corporate debt n.a. 100 percent debt 49 asset types 3 sources of 

saving for 

corporate 

sector

Noncorporate n.a. 32 percent debt, 

68 percent equity 

49 asset types 3 sources of 

saving for 

noncorporate 

sector

Tenant-occupied 

housing

2 sectors 

(corporate, 

noncorporate)

Financing by debt 

and equity shares 

for each sector as 

above

2 asset types 

(residential 

structures and 

land)

3 sources of 

saving for each 

sector

Owner-occupied 

housing

n.a. 43 percent debt, 

57 percent equity

2 asset types 3 sources of 

saving for 

homeowner 

sector

Business 2 sectors 

(corporate, 

noncorporate)

Financing by debt 

and equity shares 

for each sector as 

above

49 asset types 3 sources of 

saving for each 

sector

Overall 3 sectors Financing by debt 

and equity shares 

for each sector as 

above 

49 asset types 3 sources of 

saving for each 

sector
27

The companion average after-tax return is sc, computed in equation (11), which averages over sources of saving and sources of finance as shown by that equation. The 

aggregate ETTRc,all is computed as

The aggregate ETTR for a debt-financed corporate investment is computed the same 

way, except that the share of finance from debt, fc, is set to 1 in equations (5) and (11). 

For equity-financed corporate investment, fc is set to zero.

The aggregate effective tax rate for the noncorporate sector is derived through computations that are completely parallel to those for the corporate ETTR. Computation of 

an effective tax rate for tenant-occupied housing deviates from the two preceding 

aggregations in that it averages only two asset types, structures and land. It also differs 

by averaging shares of those assets and shares of saving for the corporate and noncorporate sectors, because both sectors invest in rental housing. The aggregate 

effective tax rate for homeowners is computed similarly to those for corporate and 

noncorporate sectors, but only for residential structures and land.

The overall effective tax rate for all investments is computed from averages of the 

before- and after-tax returns for each sector. The average before-tax return, ρall, is 

computed as

where qc, qn, and qh are the shares of the total capital stock in the corporate, noncorporate, and homeowner sectors, respectively. The average after-tax return on 

saving, s, is given by a similar expression:

Finally, the overall effective tax rate is computed by substituting ρall and s into equation (1). An overall rate for businesses is computed from similar equations as the overall rate, except that owner-occupied housing is omitted and shares represent shares of 

the two sectors.

Interquartile Range of Effective Tax Rates Among Asset Types. CBO summarized differences in tax rates among its 49 asset types with the interquartile range of effective 

total tax rates. The 49 ETTRs computed for investments by corporations with the 

typical mix of financing were ranked from highest to lowest and weighted by shares of 

the capital stock. The interquartile range is the difference between the ETTR at the 

75th percentile and that at the 25th percentile. Half of all assets have tax rates within 

that range—one-quarter have higher rates and one-quarter have lower rates. The 

(60)

(61)

(62)

c all

c all c

c all

s ETTR

,

,

, ρ

ρ − =

ρall = qcρc,all + qnρn,all + qhρh,all

c c n n h h s = q s + q s + q s
28

range gives a single measure of how much effective total tax rates differ over a large 

number of categories. A change in the tax law would alter the interquartile range if it 

systematically widened or narrowed differences in the relative ETTRs of the 49 asset 

types. Changes that affect tax rates for only a few asset types at the extremes of the distribution would have no effect on the interquartile range, nor would changes that 

affect tax rates for a minority of asset types clustered near the median tax rate.

The standard deviation is a more common measure of variation, but CBO decided 

against using it because it gives the greatest weight to the most extreme values. Effective tax rates are ratios of the tax wedge and before-tax returns, so small values for 

before-tax returns can cause extreme values for effective tax rates and inflate the standard deviation.21

Differences in effective tax rates among asset types are caused primarily by differences 

in the balance between economic depreciation and tax depreciation allowances. Those 

differences are substantially the same, regardless of sector or source of financing. For 

that reason, CBO computed the interquartile range for one sector and financing mix.

Implementation of Effective Tax Rate Calculations

To solve the equations presented in this paper, values must be assigned to the variables. First, the distribution of marginal business investments among asset types, 

sources of financing, and tax treatments must be identified, along with the tax rates 

that would apply to the return on those investments. Next, the distribution of marginal individual saving by type of account must be identified, along with the tax rates 

that would apply to the return on that saving. Depreciation schedules also must be 

defined and assets must be assigned to the appropriate schedules. Finally, the rates of 

return that apply to each type of investment must be specified.

Identifying and Taxing Marginal Investments

Prospective investors must decide which asset types to invest in, how to finance their 

investments, and under which legal forms their enterprises should be organized 

(which, in turn, determines how investments are taxed, see Box 1). CBO classified 

potential investments according to a matrix defined by 49 asset types, two sources of 

financing (debt, equity), and three tax treatments (corporate, noncorporate business, 

owner-occupied housing). It then calculated ETRs and ETTRs for most of the cells in 

the matrix.

21. Some previous studies have stabilized their measures of the standard deviation by computing them 

either for before-tax rates of return or for tax-exclusive effective tax rates (defined as tax wedges 

divided by after-tax returns). See, for example, Fullerton, Gillette, and Mackie, “Investment Incentives,” pp. 147–150. CBO decided against these approaches because CBO presented no other 

information on before-tax returns or tax-exclusive effective tax rates that would help readers judge 

the importance of the changes in the standard deviations.
29

Performing the aggregations listed in Table 2, however, requires assumptions concerning how marginal investments would be distributed among the cells; that is, values of 

B, q, f, and α must be specified. Given those assumptions, appropriate data must be 

located and procedures for operationalizing the assumptions must be implemented.

Assumptions. In general, CBO assumed that marginal investments would be distributed among the matrix cells in proportion to the value of the existing capital stock. 

Underlying that explicit assumption is the implicit assumption that the same market 

conditions that determined the distribution of investment in the past would apply in 

the future.

That assumption has its limitations. Technology, for example, is changing. Current 

marginal investments are much more likely to be in computers and peripheral equipment than in, say, agricultural machinery. The existing capital stock does not fully 

reflect that because it includes farm equipment that will not be replaced when it wears 

out. Ideally, one would want to know the economy’s profit-maximizing production 

function and weight the asset classes accordingly, but that information is not known.

Box 1.

What Is “Corporate”? What Is “Noncorporate”?

The category labels “corporate” and “noncorporate” are used to describe both a 

legal form of organization and an organization’s tax treatment. However, their 

meanings are not the same in both contexts. In this background paper, unless 

stated otherwise, the Congressional Budget Office uses the terms “corporate” 

and “noncorporate” as they apply to the tax treatment of businesses, as shown 

below. 

Source: Congressional Budget Office.

Note: n.a. = not applicable

Entity

Legal Form of

Organization Tax Treatment

C Corporation Corporate Corporate

S Corporation Corporate Noncorporate

Partnership Noncorporate n.a.

Share of partnership income 

attributable to corporate partners

n.a. Corporate

Share of partnership income 

attributable to individual partners

n.a. Noncorporate

Sole Proprietorship Noncorporate Noncorporate
30

Using actual investment from a recent year would be more distorting than using the 

existing stock of capital. To the extent that technological change causes one asset type 

to be replaced eventually by another asset type with a similar working life, actual 

investment more accurately approximates the distribution of marginal investment. 

However, using actual investment substantially overweights short-lived assets at the 

expense of longer-lived assets, even in the absence of any technological change. The 

resulting distortion is much more severe than is that caused by the delay in recognizing technological change that results from using the value of existing capital stock. 

Therefore, the value of the capital stock was deemed to be the best option for distributing marginal investment among asset types.

Using the value of existing capital stock to distribute marginal investment among the 

corporate, noncorporate, and homeowner sectors and between debt and equity 

financing also fails to consider changes in the regulatory environment and in tax law. 

For example, one might assume that the Sarbanes-Oxley Act of 2002 would alter the 

corporate sector’s share of marginal investment, either reducing it because of the compliance costs imposed on publicly traded corporations, or increasing it because of 

greater confidence in the accuracy of corporate reporting. Similarly, one might assume 

that JGTRRA would shift corporate investment toward equity financing because of 

its reduced tax rates on dividends and capital gains. The magnitude, and in some cases 

even the direction, of those shifts is highly uncertain, however. Therefore, CBO made 

no attempt to adjust for those changes.

Sources of Data. The primary source of data on the value of the existing capital stock 

was the Bureau of Economic Analysis (BEA), an agency within the Department of 

Commerce. Its Web site offers two types of tables: Detailed Fixed Asset Tables are 

disaggregated by asset type and industry (www.bea.gov/bea/dn/FA2004/Details/

Index.html), and Standard Fixed Asset Tables are less disaggregated, but still offer 

information on legal forms of organization (www.bea.gov/bea/dn/FA2004/

SelectTable.asp).

Nonresidential Assets. The 2002 value of nonresidential assets by industry and asset 

type was taken from Detailed Fixed Asset Table 2.1 (detailnonres_stk1.xls). All asset 

types in the spreadsheet were retained. Although CBO did not calculate effective tax 

rates by industry, the industry detail in the spreadsheet was, with a few exceptions, 

also retained (see Box 2). The preservation of that structure facilitated a more precise 

matching of depreciation methods with the appropriate assets than would have been 

possible had CBO used more aggregated data. 

Aggregate values for nonresidential equipment and structures by legal form of organization (corporate, partnership, sole proprietorship, nonprofit) were available from 
31

Standard Fixed Asset Table 4.1. Those figures were used as control totals in removing 

the assets of nonprofits and in distributing nonresidential assets by tax treatment (see 

below).

Residential Assets. The 2002 value of residential assets by tenure was taken from BEA’s 

Detailed Fixed Asset Table 1 (detailresidential.xls), although not all of the detail contained in the spreadsheet was retained. The spreadsheet breaks the figures down by 

legal form of organization (household, corporation, sole proprietorship, nonprofit), 

Box 2.

Aggregated Industries Used in Spreadsheet

Calculations

To arrive at its calculations, the Congressional Budget Office (CBO) used four 

aggregated industries created from those included in the Bureau of Economic 

Analysis (BEA) spreadsheet Detailed Fixed Asset Table 2.1 for nonresidential 

detailed estimates (go to www.bea.gov/bea/dn/FA2004/Details/Index.html, 

then detailnonres_stk1.xls):

B Manufacturing of transportation equipment, consisting of (1) motor 

vehicle, body, trailer, and parts manufacturing and (2) other transportation 

equipment manufacturing;

B Air, water, and rail transportation (three separate industries in the BEA 

table);

B Professional and technical services, consisting of (1) legal services, 

(2) computer systems design and related services, and (3) other professional 

and technical services; and

B Health care and social assistance, consisting of (1) hospitals and (2) nursing 

homes and residential care facilities.

CBO included all of the finance industry. Some analysts omit all or part of that 

industry, presumably because the industry can be viewed as part of the process 

by which individual saving is allocated to investments of nonfinancial firms. In 

that approach, taxes born by the finance industry should be reflected in the 

effective total tax rates of nonfinancial firms. Instead, CBO’s analysis included 

the fixed assets of the finance industry in the same manner as investments in 

other industries because they are indistinguishable from the assets of any other 

business. The “part of the process” argument has more relevance to calculating 

shares of debt and equity financing, which is discussed in the main text.
32

tenure (owner- or tenant-occupied), size (1–4 units, 5+ units), and type of asset (new 

structure, additions and alterations to structure, major replacement, manufactured 

home, equipment). All nonprofit data were omitted; their treatment is discussed later. 

The remaining figures for equipment and structures were aggregated separately for 

tenure and legal form of organization.22 (The form-of-organization split is used below 

in determining the distribution by tax treatment.)

Land. The value of land was derived from data on capital inputs that were assembled 

by the Bureau of Labor Statistics (BLS) in 2005.23 Those data provide the stock of 

wealth in land, structures (nonresidential, residential), equipment, and inventories for 

three major sectors of the economy: manufacturing, agriculture, and the rest of private business—the nonmanufacturing and nonfarm sectors. The wealth data were in 

2000 dollars, and the price indexes provided by BLS allowed CBO to convert the 

values to 2002 dollars.

BLS obtained most of its land values by imputation. The exception is values of agricultural land, which were collected by the Department of Agriculture. For all other 

land, BLS multiplied values of structures by ratios of the value of land to the value of 

the structures. Those ratios were based on unpublished estimates by the Bureau of the 

Census.24 CBO reconstructed the ratios from the BLS wealth data for 2002 and 

applied the ratios to the value of structures in the BEA data identified above. CBO 

did not take the land values directly from BLS because its data on structures differ 

from those used by BEA.

22. CBO mistakenly included $86 billion worth of owner-occupied structures on farms operated by 

sole proprietors in the total of tenant-occupied noncorporate structures. Those structures should 

have been included with other owner-occupied structures. That mistake raised the total of tenantoccupied structures owned by noncorporate businesses by 3.6 percent and lowered the amount of 

owner-occupied structures by 0.8 percent. It also raised the effective tax rate on all tenant-occupied 

housing from 18.1 percent to 18.2 percent in Table 1 of Taxing Capital Income; no other change 

was large enough to distort the rates reported in that paper.

23. The data CBO downloaded are dated February 1, 2005. Newer data, dated March 23, 2006, are 

available. The new data differ somewhat from those used by CBO, reflecting North American 

Industrial Classification System instead of Standard Industrial Classification system classifications 

and updated information on land and other capital stocks. Go to www.bls.gov, select “Productivity,” then “Multifactor Productivity,” then “Get Detailed MFP Statistics,” then “Download comprehensive tables of multifactor productivity and related capital data for private business, private 

nonfarm business and manufacturing,” then “1987–2004 Capital Detail Data by Asset Type for 

Major Sectors.”

24. U.S. Department of Labor, Bureau of Labor Statistics, BLS Handbook of Methods, Bulletin 2490

(1997), p. 92.
33

CBO combined the data for nonresidential and residential structures from BEA’s 

Standard Fixed Asset Tables 4.1 and 5.1 to get structures for the three sectors BLS 

used: farm, manufacturing, and the remainder of private business. From the data provided in the two BEA tables, the structures given for each sector were divided into 

corporate and noncorporate businesses—in this case, “corporate” includes C and S 

corporations. CBO then applied the ratios from the BLS data to compute the amount 

of land in each sector by form of business organization. The total amount of land held 

by corporations and by other businesses was obtained by adding the amounts each 

type of business held in the farm, manufacturing, and other sectors.

Finally, the BLS data omitted the value of land in owner-occupied housing. That 

value was obtained by subtracting the value of owner-occupied structures (from the 

BEA’s Standard Fixed Asset Table 5.1 noted above) from the total value of owneroccupied real estate (from the Flow of Funds data).25 The result was an aggregate value 

of land in 2002 of $7,518 billion.

Inventories. BEA’s Table 5.7.5.B of the National Income and Product Accounts 

(NIPAs) provides values of private inventories by quarter (www.bea.gov/bea/dn/

nipaweb/SelectTable.asp). CBO used those data as revised on April 28, 2005. Because 

the nation’s economy in 2002 was in the early recovery phase from a recession and 

because inventories fluctuate over business cycles, CBO averaged data from 1996 

through 2003 to arrive at a “normal” amount for inventories to accompany the rest of 

the capital stocks valued in that year. CBO computed the ratio of private inventories 

from BEA’s NIPA Table 5.7.5.B to the value of private fixed assets listed in BEA’s 

Detailed Fixed Asset Table 2.1 on capital stocks. The ratios were computed with 

fourth-quarter inventories to match end-of-year values for the capital stocks. In the 

years of strong growth, 1996–2000, inventories dropped from 7.7 percent to 

7.2 percent of fixed assets; in 2001–2003, the years of recession and slow recovery, 

inventories fell from 6.5 percent to 6.3 percent of fixed assets. The average ratio was 

7.0 percent; applying that ratio to the value of fixed assets of $23,530 billion in 2002 

yielded inventories of $1,653 billion. 

Other Data. The BEA data are not sufficiently detailed to use for identification of the 

assets of nonprofits or to allocate assets by tax treatment. However, most of the necessary detail can be extracted from tax data compiled in publications of the IRS Statistics of Income (SOI) division. The rest of the detail can be extracted from the Census 

of Agriculture (COA).

Three sources of tax data were consulted (see Box 3) and used to extract fields that 

covered the value of depreciable assets, accumulated depreciation, inventories, and 

land by industry and form of organization. The 2002 Census of Agriculture was used 

25. Board of Governors of the Federal Reserve System, Flow of Funds Accounts of the United States

(March 10, 2005), Table B.100, “Real Estate of Household for 2002” ($13,701.4 billion).
34

because the SOI division does not report data for farms that are sole proprietorships. 

The value of land and buildings, the value of machinery and equipment, and acreage 

owned by legal form of organization were extracted from COA Table 58.26

Box 3.

Sources of Tax Data Used to Supplement 

Bureau of Economic Analysis Data

26. U.S. Department of Agriculture, National Agricultural Statistics Service, “United States Summary 

and State Data,” 2002 Census of Agriculture, Vol. 1, Part 51 (June 2004). Table 58 is available at 

www.nass.usda.gov/census/census02/volume1/us/st99_1_058_058.pdf.

In its analysis, the Congressional Budget Office used corporate, partnership, and sole 

proprietorship tax data in its analysis from the following sources. The list identifies the 

source table for each variable referenced in the text.

B Internal Revenue Service, Statistics of Income—2001 Corporate Income Tax Returns

(2004).

Table 6 (All active corporations)

Depreciable assets by minor industry

Accumulated depreciation by minor industry

Land

End-of-year inventories

Interest paid

Capital stock

Additional paid-in capital

Retained earnings (appropriated and unappropriated)

Cost of treasury stock

Table 14 (S corporations)

Depreciable assets by minor industry 

Accumulated depreciation by minor industry 

Land

End-of-year inventories

Interest paid

Capital stock

Additional paid-in capital

Retained earnings (appropriated and unappropriated)

Cost of treasury stock

The tables are available at 

www.irs.gov/taxstats/bustaxstats/article/0,,id=112834,00.html.
35

Removing Nonprofits from the BEA Data. The BEA figures by asset type and industry 

include the assets of nonprofit organizations. Nontaxable entities incur no tax burdens on their investments, so it is not necessary to calculate effective tax rates on their 

assets. Retaining those assets in the data would overweight the effective tax rates on 

asset types that are most commonly owned by nonprofits. The most straightforward 

step was to delete religious buildings from the BEA data. Otherwise, the nonprofits’ 

assets were identified as follows, then subtracted from the reported BEA amounts.

Box 3.

Continued

B Tim Wheeler and Maureen Parsons, “Partnership Returns, 2002,” Statistics of 

Income Bulletin (Fall 2004), pp. 46–125, available online: www.irs.gov/pub/irs-soi/

02partnr.pdf.

Table 1

Depreciation deductions by minor industry

Beginning-of-year inventories

Table 3

Depreciable assets by major and minor industry

All partnerships

Partnerships with net income

Accumulated depreciation by major and minor industry

All partnerships

Partnerships with net income

Land

Table 5

Net income or loss by type of partner and major industry

Note that “Minor industries” are those listed in Table 1, and “major industries” are 

those listed in Table 5, except that four categories of lessors of buildings and property 

are aggregated.

B Kevin Pierce and Michael Parisi, “Sole Proprietorship Returns, 2002,” Statistics

of Income Bulletin (Summer 2004), pp. 6–64, available at 

www.irs.gov/pub/irs-soi/02solp.pdf.

Table 2

Depreciation deductions by minor industry

Beginning-of-year inventories
36

1. Depreciable assets, minus accumulated tax depreciation by industry, were tabulated from SOI data and compared with the corresponding BEA values.27 The 

SOI tabulations necessarily exclude nonprofits, which do not file tax returns.28

Therefore, a large difference between the BEA amount for an industry and the corresponding SOI amount implies a large nonprofit presence in that industry. Each 

of the following industries, which have the lowest ratios of SOI assets to BEA 

assets, was identified as having a significant nonprofit component:

• Educational services,

• Health care and social assistance—offices of health practitioners and outpatient 

care centers,

• Health care and social assistance—hospitals, nursing homes, and residential care 

facilities,

• Arts, entertainment, and recreation—other arts and entertainment (such as 

museums and performing arts organizations), and

• Other services (including religious, grantmaking, civic, and professional 

organizations).

2. For each identified industry, the ratio of SOI assets to BEA assets was normalized 

to the average for industries without a significant nonprofit component (excluding 

banking and real estate). To estimate the value of assets held by nonprofit organizations, one minus the normalized ratio was applied to the BEA value of all types of 

assets.

3. Equipment and structures in identified industries were each multiplied by a separate adjustment factor to align with BEA control totals for equipment and structures owned by nonprofits (see BEA’s Standard Fixed Asset Table 4.1).

Allocating Assets Between Corporate and Noncorporate Tax Treatments. Assets subject to corporate tax treatment are those owned by C corporations and the share of 

those owned by partnerships that can be attributed to corporate partners. Assets subject to noncorporate tax treatment are those owned by S corporations, sole proprietors, and the portion of those owned by partnerships that can be attributed to 

individual partners. CBO used the following steps in identifying the amounts 

presented, by minor industry (see Table 3):

27. For sources of the depreciable assets of corporations and partnerships, see Box 3. Depreciable assets 

of sole proprietorships were imputed, as described below.

28. Although nonprofits do not file their own tax returns, they may be partners in a partnership that 

files a Form 1065. Assets attributable to such partners are removed in a later step.
37

1. Allocate corporate assets between C and S corporations.

2. Allocate partnership assets between corporate and individual partners.

3. Impute the value of assets to nonfarm sole proprietorships.

4. Impute the value of assets to farm sole proprietorships and calibrate other farm 

assets.

After those amounts were identified for each industry, the overall share of marginal 

investment subject to the corporate tax was calculated for each industry. Those values 

were converted into corporate shares by type of asset by weighting industry-specific 

shares according to the industry distribution of each asset type (see the appendix).29

Allocating Corporate Assets. An estimate of the value of existing capital stock (specifically, depreciable assets minus accumulated depreciation) was calculated from SOI 

data (see Box 3) for all active corporations and S corporations, by minor industry. The 

figures were then adjusted to align with BEA control totals for 2002. Separate control 

totals were available for farms, manufacturing, and all other industries. The resulting 

adjustment factors, also applied to the S corporation data, were as follows: farms, 

1.74; manufacturing, 1.32; other, 2.48. The adjusted S corporation amounts were 

assigned to the noncorporate tax treatment; the difference between all corporations 

and S corporations was attributed to C corporations and assigned to the corporate tax 

treatment (see Table 4 on page 42).

Corporate tax data also were used to allocate land and inventories between C and S 

corporations.30 No control totals were available, however, so the unadjusted amounts 

were assigned to a tax treatment in the same manner as other capital stock.

Allocating Partnership Assets. CBO used SOI data (see Box 3) to calculate the current 

value of depreciable assets by major industry for all partnerships and for partnerships 

with net income. The current value of depreciable assets for partnerships with a net 

loss was calculated as the difference between those two values. That permitted calculation of two ratios for each major industry: for profitable partnerships, the current 

value of depreciable assets to net income; for unprofitable partnerships, current value 

of depreciable assets to net loss.

29. For corporate-owned, tenant-occupied housing, the corporate share was based on the C-to-S 

corporation split for the real estate industry. All other tenant-occupied housing was assigned a 

corporate share of zero. The corporate share of residential equipment was calculated directly from 

BEA data, assuming that none of it was held by S corporations.

30. To maintain compatibility between corporate tax data (from 2001) and noncorporate tax data 

(from 2002), end-of-year inventories were used for corporations and beginning-of-year inventories 

were used for noncorporate businesses.
38

Table 3.

Allocation of Assets Among Forms of Organization and 

Tax Treatment Categories, by Minor Industry

(Percent)

Continued

Those ratios were applied to the net income or loss of corporate partners, individual 

partners, and nonprofit partners in the industry as appropriate—the former if the 

amount was positive and the latter if the amount was negative. That technique misses 

most of the variation between profitable and unprofitable partnerships, but at least it 

renders positive values of assets for all types of partners in all industries. The corporate, individual, and nonprofit shares of the capital stock were then calculated by 

major industry.

Farm structures 8.1 91.9 7.4 92.6

Farm equipment 17.5 82.5 13.6 86.4

hunting 82.9 17.1 40.8 59.2

Mining 90.2 9.8 92.3 7.7

Utilities 98.2 1.8 99.6 0.4

Construction

Building construction 83.8 16.2 43.6 56.4

Heavy construction, land subdivision 81.3 18.7 51.6 48.4

Specialty trade contractors 97.9 2.1 52.9 47.1

Manufacturing

Food, beverage, tobacco 95.8 4.2 89.6 10.4

Textiles, textile products 96.9 3.1 86.6 13.4

Apparel, leather, allied products 97.4 2.6 74.1 25.9

Wood products 95.3 4.7 77.1 22.9

Paper 98.5 1.5 95.0 5.0

Printing, related activities 96.9 3.1 70.7 29.3

Petroleum, coal products 94.0 6.0 99.2 0.8

Chemicals 94.7 5.3 98.1 1.9

Plastics, rubber products 95.9 4.1 81.3 18.7

Nonmetallic mineral products 97.0 3.0 88.9 11.1

Primary metals 95.9 4.1 91.5 8.5

Fabricated metal products 96.3 3.7 74.4 25.6

Machinery 97.7 2.3 91.6 8.4

Computers, electronic products 98.7 1.3 98.3 1.7

Electrical equipment, appliances,

components 99.5 0.5 96.3 3.7

Transportation equipment 99.4 0.6 98.2 1.8

Furniture, related products 97.2 2.8 79.2 20.8

Miscellaneous manufacturing 96.1 3.9 83.8 16.2

Industry 

Form of Organization

Corporate

Partnership or Tax Treatment

Equipment and Structures

Noncorporate

Agriculture, Forestry, Fishing, Hunting

Corporation Sole Proprietorship

Support activities, forestry, fishing, 
39

Table 3.

Continued

(Percent)

Continued

Wholesale Trade

Durable goods 99.2 0.8 81.4 18.6

Nondurable goods 98.6 1.4 87.2 12.8

Retail Trade

Motor vehicles, parts 96.4 3.6 50.9 49.1

Furniture, home furnishings 96.8 3.2 59.8 40.2

Electronics, appliances 94.8 5.2 78.8 21.2

Building materials, garden supplies 98.5 1.5 85.9 14.1

Food, beverage 97.9 2.1 86.3 13.7

Health, personal care 98.3 1.7 89.0 11.0

Gasoline 92.0 8.0 47.6 52.4

Clothing, accessories 98.7 1.3 92.8 7.2

Sporting goods, hobby items, 

97.3 2.7 82.6 17.4

General merchandise 99.4 0.6 98.7 1.3

Miscellaneous stores 91.6 8.4 68.7 31.3

Nonstore retailers 89.3 10.7 66.0 34.0

Transportation, Warehousing

Air, rail, water 99.5 0.5 96.4 3.6

Truck 93.9 6.1 63.1 36.9

Transit, ground passenger transportation 97.0 3.0 73.2 26.8

Pipeline 46.3 53.7 68.5 31.5

Other transportation, support activities 96.7 3.3 88.1 11.9

Warehousing, storage 87.1 12.9 60.7 39.3

Information

Publishing 98.4 1.6 92.9 7.1

Motion pictures, sound recording 93.8 6.2 91.4 8.6

Broadcasting, telecommunications 96.7 3.3 99.3 0.7

Information, data processing 98.7 1.3 97.7 2.3

Finance, Insurance

Credit intermediation 98.7 1.3 94.4 5.6

Securities, commodity contracts, 

other financial investments 91.7 8.3 89.7 10.3

Insurance 99.6 0.4 97.6 2.4

Other financial vehicles 99.8 0.2 99.9 0.1

Form of Organization

Partnership or Tax Treatment

Industry Corporation Sole Proprietorship Corporate Noncorporate

Equipment and Structures (Continued)

books, music
40

Table 3.

Continued

(Percent)

Source: Congressional Budget Office calculations based on the 2002 Census of Agriculture and the 

following Internal Revenue Service Statistics of Income data: 2001 corporate income tax 

returns, 2002 partnership returns, and 2002 nonfarm sole proprietorship returns.

Real Estate, Rental, Leasing

Real estate 30.9 69.1 23.2 76.8

Rental, leasing (including nonfnancial 

intangible assets) 89.5 10.5 79.1 20.9

Professional, Scientific, Technical Services 80.5 19.5 66.5 33.5

Management of Companies 97.9 2.1 95.4 4.6

91.4 8.6 67.3 32.7

95.1 4.9 84.1 15.9

Educational Services 82.0 18.0 57.1 42.9

Health Care, Social Assistance

Health practitioners' offices, outpatient

care centers 86.8 13.2 60.7 39.3

Miscellaneous health care, social 

assistance 80.8 19.2 69.5 30.5

Hospitals, nursing homes, residential 

care facilities 89.5 10.5 78.1 21.9

Arts, Entertainment, Recreation

Amusement, gambling, recreation 

services 86.9 13.1 63.1 36.9

Other arts, entertainment 83.6 16.4 55.5 44.5

Accommodations, Food Services

Accommodations 82.9 17.1 70.1 29.9

Food, beverage 94.2 5.8 66.5 33.5

Other Services

Repair, maintenance 84.2 15.8 38.6 61.4

Personal, laundry services 88.8 11.2 48.2 51.8

51.1 48.9 46.8 53.2

85.7 14.3 72.0 28.0

Tax Treatment

Industry Corporation Sole Proprietorship Corporate Noncorporate

Land (Except owner-occupied housing)

Inventories

Equipment and Structures (Continued)

Partnership or

All Industries

All Industries

Form of Organization

Waste management, remediation

Administrative, Support, Waste 

Management, Remediation Services

Administrative, support services
41

Next, the current value of depreciable assets was estimated for all partnerships by 

minor industry. The resulting estimates were adjusted by a factor of 0.43 to align with 

BEA control totals for partnership assets, then allocated among corporate, individual, 

and nonprofit partners on the basis of the shares associated with the major industry 

under which the minor industry falls.31 The corporate share was assigned to the corporate tax treatment and the individual share was assigned to the noncorporate tax 

treatment (see Table 5 on page 45). The nonprofit share was dropped from the

analysis.

Land in each major industry was allocated among corporate, individual, and nonprofit partners using the same distribution as for depreciable assets. The results were 

then aggregated over all industries. Inventories were allocated among the three types 

of partners using shares calculated for depreciable capital over all partnerships. No 

control totals were available for land or inventories, however, so the unadjusted 

amounts were assigned directly to the appropriate tax treatment.

Imputing Assets to Nonfarm Sole Proprietorships. Most assets of sole proprietorships are 

not reported by the SOI. They therefore were imputed, in keeping with the assumption that sole proprietors deploy assets similarly to partnerships in the same industry. 

Using partnership data, two ratios were calculated by minor industry: current-year 

depreciation deductions to the current value of depreciable assets (see Table 4), and 

the value of land to the current value of depreciable assets (see Box 3).32

The first set of ratios was applied to depreciation deductions of nonfarm sole proprietorships in the same minor industry. The resulting estimates of the current value of 

depreciable assets were adjusted by a factor of 0.47 to align with BEA control totals 

for nonfarm sole proprietorship assets and then assigned the noncorporate tax 

treatment.

Next, to estimate the value of land, the second set of ratios was applied to the imputed 

current value of depreciable assets by minor industry. Those results were aggregated 

over all industries, and—in the absence of a control total—assigned directly to the 

noncorporate tax treatment without adjustment.

Inventories for nonfarm sole proprietorships are reported by the SOI. Therefore, no 

imputation was necessary.

31. See Tim Wheeler and Maureen Parsons, “Partnership Returns, 2002,” Statistics of Income Bulletin

(Fall 2004), Table 5, available at www.irs.gov/pub/irs-soi/02partnr.pdf. Partners that are themselves 

partnerships and partners who are nominees are also broken out in the data. Those partnerships 

were ignored under the assumption that their assets ultimately would be distributed among tax 

treatments in proportion to the three categories that were retained.

32. Basing the imputation on S corporations rather than on partnerships does not result in a substantially different distribution of sole proprietorship assets across industries.
42

Table 4.

Allocation of Assets Among Tax Treatments for 

Corporations and Sole Proprietorships, by Minor Industry

Continued

Agricultural production 55.1 44.9 4.43

Forestry, logging 55.9 44.1 5.65

Support activities, fishing, hunting, trapping 42.5 57.5 2.73

94.0 6.0 0.11

99.8 0.2 0.10

50.8 49.2 4.50

61.5 38.5 1.36

53.5 46.5 7.29

86.7 13.3 0.15

95.1 4.9 0

87.1 12.9 0.35

76.0 24.0 0.80

68.2 31.8 2.10

78.1 21.9 0.62

95.0 5.0 0

71.7 28.3 1.15

99.4 0.6 0

98.3 1.7 0.01

81.2 18.8 0.12

89.4 10.6 0.27

91.5 8.5 0.03

75.1 24.9 0.60

92.3 7.7 0.48

98.3 1.7 0.01

96.4 3.6 0.08

98.3 1.7 0.11

80.5 19.5 1.70

84.0 16.0 0.18

81.7 18.3 0.48

87.7 12.3 0.43

Equipment and Structures

Computers, electronic products

Electrical equipment, appliances, 

Transportation equipment

Furniture, related products

components

Miscellaneous manufacturing

Partnership Assets

Nonmetallic mineral products

Primary metals

Building, developing, general contracting

Heavy construction

Special trade contractors

Industry

Agriculture, Forestry, Fishing, Hunting

(Percent) (Percent)

Sole Proprietorship

Manufacturing

Food 

Beverages, tobacco products 

Textiles, textile products

Apparel

Leather, allied products

Assets/

Corporations

C Corporations

Assets Owned by

S Corporations

Assets Owned by

Construction

Machinery

Wood products

Paper

Printing, related activities

Petroleum, coal products

Chemicals

Plastics, rubber products

Fabricated metal products

Mining

Utilities

Wholesale Trade

Durable goods

Nondurable goods
43

Table 4.

Continued

Continued

Imputing the Value of Assets to Farm Sole Proprietorships and Calibrating Other Farm 

Assets. The 2002 COA reports the value of farmland and structures, R, and the value 

of equipment, Q, for farms owned by corporations, c, partnerships, p, and sole proprietors, s. Instead of using tax data, CBO used the COA as its benchmark for farm assets 

because only the COA includes sole proprietorships. To be useful for the allocation of 

assets to the corporate or noncorporate tax treatments, however, the COA figures 

must be rearranged to conform to the way asset data are reported for tax purposes: It is 

necessary to isolate the value of land, L, while combining the values of structures and 

equipment, K, such that L + K = R + Q.

51.7 48.3 0.89

61.1 38.9 1.52

81.0 19.0 0.36

87.1 12.9 3.01

87.3 12.7 0.40

90.3 9.7 1.84

48.8 51.2 0.55

93.8 6.2 1.04

84.3 15.7 1.54

99.1 0.9 0.63

74.1 25.9 4.52

71.2 28.8 1.30

96.8 3.2 0.35

66.9 33.1 8.57

75.3 24.7 5.73

97.6 2.4 0

90.8 9.2 2.30

63.7 36.3 0.70

93.1 6.9 0.20

91.9 8.1 0.14

99.3 0.7 0

97.7 2.3 0.30

95.0 5.0 0.17

93.2 6.8 0.09

97.9 2.1 5.89

99.9 0.1 0

financial investments

Information, data processing

Finance, Insurance

Credit intermediation

Securities, commodity contracts, other 

Clothing, accessories

Sporting goods, hobby items, books, music

General merchandise

Building materials, garden supplies

Food, beverage

Health, personal care

Gasoline

Pipeline

Other transportation, support activities

Other financial vehicles

Insurance

Warehousing, storage

Information

Publishing

Motion picture, sound recording

Broadcasting, telecommunications

Air, rail, water

Truck

Transit, ground passenger transportation

Retail Trade

Motor vehicles, parts

Furniture, home furnishings

Miscellaneous stores

Nonstore retailers

Electronics, appliances

Transportation, Warehousing

Industry (Percent)

Assets/

Corporations

Assets Owned by Assets Owned by Sole Proprietorship

C Corporations S Corporations

(Percent) Partnership Assets

Equipment and Structures (Continued)
44

Table 4.

Continued

Source: Congressional Budget Office calculations based on the 2002 Census of Agriculture and the 

following Internal Revenue Service Statitistics of Income data: 2001 corporate income tax 

returns, 2002 partnership returns, and 2002 nonfarm sole proprietorship returns.

Note: n.a. = not applicable.

For partnerships, proxy values of L and K (from SOI data, see Box 3) can be used to 

estimate corresponding values that are consistent with the COA. First, L′/(L′ + K′) 

was calculated. The result, 53.3 percent, was applied to the COA value of Rp + Qp to 

arrive at an estimate for Lp.

 The value of Kp was then calculated as Rp + Qp − Lp.

No proxies for L and K were available from SOI data for sole proprietorships. Therefore, it was assumed that the distribution of the value of farmland between partnerships and sole proprietorships was proportional to the distribution of acreage, A, as 

48.9 51.1 0.40

82.6 17.4 0.26

88.9 11.1 0

75.2 24.8 1.00

96.2 3.8 0

Administrative, support services 72.2 27.8 2.38

Waste management, remediation 86.4 13.6 0.37

67.5 32.5 2.03

67.9 32.1 1.57

79.4 20.6 0.42

83.3 16.7 0.08

66.5 33.5 0.19

59.7 40.3 0.41

72.5 27.5 0.12

68.0 32.0 0.51

45.7 54.3 8.38

54.1 45.9 4.39

76.5 23.5 0.78

78.2 21.8 n.a.

(Percent) (Percent) Partnership Assets

care centers

Equipment and Structures (Continued)

Health Care, Social Assistance

Health practitioners' offices, outpatient care 

Real Estate, Rental, Leasing

Industry

S Corporations Assets/

Corporations

Assets Owned by Assets Owned by Sole Proprietorship

Land

Inventories

C Corporations

All Industries

All Industries

Other arts, entertainment

Real estate

Amusement, gambling, recreation services

Management of Companies

Educational Services

Hospitals, nursing homes, residential care 

facilities

Arts, Entertainment, Recreation

Miscellaneous health care, social 

Administrative, Support, Waste Management,

assistance

Rental, leasing

Lessors of nonfinancial intangible assets

Professional, Scientific, Technical Services

Remediation Services

Accommodations, Food Services

Personal, laundry services

Accommodations

Food, beverage

Other Services

Repair, maintenance
45

Table 5.

Allocation of Assets Among Tax Treatments for 

Partnerships, by Major Industry

Source: Congressional Budget Office calculations based on the 2002 Census of Agriculture and 

2002 partnership returns from Internal Revenue Service Statitstics of Income data.

Note: Rows do not add to 100 percent. Assets owned by nonprofit partners account for the

remainder.

b. Allocation of land is the same as allocations for equipment and structures, by industry.

24.1 74.2

83.9 14.7

87.1 11.9

39.0 61.0

95.3 4.4

76.6 23.3

54.1 44.1

40.8 53.5

98.0 1.6

66.0 33.7

45.1 33.0

66.0 33.7

48.0 0.9

19.5 76.0

30.6 56.7

55.9 40.4

20.6 78.9

54.2 41.9

56.2 43.8

30.6 67.9

35.5 61.0

48.4 51.0

65.4 33.4

6.8 92.7

a a

39.1 59.8

Other financial vehicles

Accommodations, Food Services

Other Services

Administrative, Support, Waste Management, 

Education Services

Health Care, Social Assistance

Industry

Real Estate, Rental, Leasing

Lessors of real estate

Agriculture, Forestry, Fishing, Hunting

Mining

Utilities

Construction

Manufacturing

Percentage Ownership

Corporate

Partners

Individual

Partners

Information

All Industries

All Industries

Remediation Services

Other real estate

Arts, Entertainment, Recreation

Credit intermediation

Rental, leasing

Professional, Scientific, Technical Services

Management of Companies

Equipment and Structures

Land

Inventories

Finance, Insurance

Securities, commodity contracts, other financial

investments

Insurance

Wholesale Trade

Retail Trade

Transportation, Warehousing
46

reported in the COA. The value of farmland owned by sole proprietorships was 

estimated as follows:

The value of Ks was then calculated as Rs + Qs − Ls.

Values of Lc and Kc were estimated in the same manner as for partnerships. The value 

of Kc was calibrated to the BEA control total for farm assets owned by corporations. 

The sum of Ks

 and Kp was similarly calibrated to the BEA control total for farm assets 

owned by noncorporate businesses. Finally, Kc was apportioned between the corporate 

and noncorporate tax treatments on the basis of the S corporation percentage calculated earlier for the agricultural production industry. Kp was similarly apportioned on 

the basis of the percentage attributable to corporate partners calculated earlier for the 

entire agriculture industry.

Allocating Assets Between Debt and Equity Financing. Data on type of financing are 

available by form of business organization, but not by asset type. Therefore, marginal 

investments, regardless of asset type, were assumed to be financed in proportion to 

existing financing arrangements by form of organization. In general, the data were 

taken from the Federal Reserve’s March 10, 2005, release of the Flow of Funds.33 The 

tables used, and the data extracted from each, were as follows:

B B.100: Value of owner-occupied houses;

B L.102: Liabilities of nonfarm nonfinancial corporations, by type of instrument;

B L.103: Liabilities of nonfarm noncorporate business, by type of instrument;

B L.104: Liabilities of farm businesses, by type of instrument;

B L.208: Commercial paper outstanding (financial corporations);

B L.210: Agency- and GSE- (government-sponsored enterprise) backed securities 

outstanding (financial corporations);

B L.212: Corporate bonds outstanding (financial corporations);

B L.213: Corporate equity outstanding, by sector (nonfinancial, financial);

B L.215: Bank loans (n.e.c., not elsewhere classified) outstanding (financial 

corporations);

(63)

33. Board of Governors of the Federal Reserve System, Flow of Funds Accounts of the United States

(March 10, 2005), available at www.federalreserve.gov/releases/z1/20050310/. The most recent 

data are available at www.federalreserve.gov/releases/z1/Current/.

Ls = Lp × As ÷ Ap
47

B L.216: Other loans and advances outstanding (financial corporations);

B L.217: Total mortgages (financial corporations);

B L.218: Home mortgages (households); and

B L.228: Proprietors’ equity in noncorporate business, by sector (farm, nonfarm).

Corporations. The Flow of Funds report generally distinguishes between financial and 

nonfinancial corporations. The mix of liabilities differs greatly for those two, as does 

the propensity to invest in equipment and structures. The differences imply that 

simply combining the debt and equity of financial corporations with that of nonfinancial corporations might not accurately reflect the mix of financing that would be 

associated with marginal investment in equipment and structures. Debt and equity 

were therefore extracted separately from the Flow of Funds report for financial and 

nonfinancial corporations. Corporate equity was $7,907.1 billion for nonfinancial 

corporations and $2,618.8 billion for financial corporations. Nonfinancial corporation debt was $4,785.1 billion; financial corporation debt was $6,979.6 billion.

SOI data for corporations in 2001 were used to identify the portion of debt and 

equity attributable to S corporations (see Box 3). Debt was assigned in proportion to 

interest deductions: 1.0 percent for financial corporations and 5.8 percent for nonfinancial corporations. Equity was assigned in proportion to the sum of capital stock, 

additional paid-in capital, and retained earnings minus treasury stock: 0.3 percent for 

financial corporations and 6.4 percent for nonfinancial corporations. The resulting 

S corporation amounts were subtracted from corporate totals (leaving the amount for 

C corporations) and added to noncorporate businesses, as described below.

The data indicate that financial C corporations finance 72.6 percent of their investments with debt; for nonfinancial C corporations, the figure is 37.9 percent. According to the BEA data, 9.86 percent of corporate equipment and structures were held in 

the financial services industry. The weighted-average percentage of marginal C corporation investments financed by debt, fc, was calculated as follows:

Noncorporate Business. The Flow of Funds report presents data separately for noncorporate farms and nonfarm businesses.34 Nonfarm noncorporate debt was 

$2,107.8 billion, and farm debt was $199.8 billion. Noncorporate equity was 

$4,057.9 billion for nonfarm businesses and $1,076.9 billion for farms. Figuring in 

the amounts attributable to S corporations from above, noncorporate investment 

financed by debt, fn, was estimated at 32.3 percent.

Financial Nonfinancial Weighted (64) (72.6 × 0.0986) + (37.9 × 0.9014) = 41.3

34. The data for farms actually include some corporations. For this exercise, however, all farms were 

assigned to the noncorporate sector.
48

Owner-Occupied Housing. For purposes of an analysis of effective tax rates, homeowner debt consists entirely of home mortgages—$5,909.5 billion, according to the 

Flow of Funds report. The total value of owner-occupied housing was $13,701.4 billion, and the average share financed by debt was 43.1 percent. As with the corporate 

and noncorporate sectors, CBO assumed that the marginal investment in owneroccupied housing, fh, is funded with the same share of debt.

Of course, individual homeowners typically have their highest debt share at the time 

of purchase. The share of debt is gradually reduced as the mortgage is paid off and as 

the home appreciates in value. Refinancing interrupts the process, but the trend is still 

toward a lower share of debt over time. The methodology of effective tax rates, however, is concerned with the debt share over the life of an investment, not with the variation within those years. From that perspective, the average share of debt among all 

homeowners is a better guide to the debt share of a marginal investment than is the 

debt share at the time a home is purchased.

Identifying the Marginal Tax Rate for Business Entities. Marginal tax rates must be 

estimated for application in each sector.

Corporate Profits. The average marginal rate at which corporate profits are taxed, u,

was assumed to be 35 percent—the highest statutory rate on the corporate tax schedule. Use of that rate assumes that the marginal investment is made by a profitable corporation in the top tax bracket. Businesses in lower corporate tax brackets—a group 

that holds barely 2 percent of the assets of profitable corporations—generally have 

assets of less than $5 million. The CBO analysis omitted the recently enacted deduction for productive activity because it had not analyzed how broadly the deduction 

would apply to corporate income.35 That credit will be completely phased in by 

2010, and by that time it would reduce the statutory tax rate on qualifying income by 

as much as 9 percent.

Noncorporate Business Income. The average marginal rate at which noncorporate business income is taxed, tn, was assumed to be 26.7 percent.36 CBO estimated that rate 

using its individual income tax model, limiting the analysis to tax returns with positive taxable income and positive noncorporate business income (defined, in terms of 

schedules of Form 1040, as the sum of positive Schedule C income, positive Schedule 

F income, and positive values of four items from Schedule E—real estate rental 

income, partnership income, S corporation income, and farm rental income). Unlike 

35. The deduction relating to income attributable to production activities in the United States was 

enacted in section 102 of the American Jobs Creation Act of 2004. For a description of the provision, see United States Congress, Joint Committee on Taxation, General Explanation of Tax 

Legislation Enacted in the 108th Congress (May 2005), p. 170.

36. A computational error in combining the different sources of noncorporate business income 

rendered the tax rate slightly higher than it should have been. The correct value would be 

26.4 percent.
49

the corporate tax rate, the noncorporate tax rate explicitly accounts for businesses in 

tax brackets other than the highest one—a much more common phenomenon among 

noncorporate businesses than among corporations.

Owner-Occupied Housing. The marginal rate at which the implicit rent on owneroccupied housing is taxed is, by law, zero. Nevertheless, because interest and property 

tax payments are deductible, it was necessary to include an average marginal rate for 

those deductions, th.

37 That rate was estimated, using the CBO individual income tax 

model, at 19.4 percent. Unlike the other rates, that rate was not applied to all interest 

paid; taxpayers who do not itemize their deductions derive no benefit from the 

deductibility of interest. Mortgage interest actually deducted on tax returns in 2002 

was 94 percent of mortgage interest payments reported by BEA.38 Therefore, the tax 

rate was applied, through λh, to 94 percent of interest paid.

Identifying and Taxing Marginal Saving

The income earned by marginal investments flows through to individuals, where it 

registers as a return on marginal saving. There, it can accrue in one of three types of 

accounts, each taxed differently:

B Nontaxable: interest, dividends, and capital gains accruing in IRAs and qualified 

employment-based retirement plans;39

B Temporarily deferred: interest, dividends, and capital gains accruing in whole-life 

insurance policies and nonqualified annuities, and capital gains accruing outside 

tax-favored accounts; and

B Fully taxable: interest and dividends accruing outside tax-favored accounts.

37. The amount of the property tax deduction was estimated using an average national rate of 

1.17 percent. That rate was calculated as the unit-weighted average tax paid per $1,000 of value. 

See Bureau of the Census, American Housing Survey of the United States: 2003 (2004), Table 1A-7; 

available at www.census.gov/hhes/www/housing/ahs/ahs03/tab1a7.htm.

38. Nearly $337 billion in mortgage interest was reported on tax returns in 2002. See Internal Revenue 

Service, Statistics of Income—2002 Individual Income Tax Returns (2004), Table 2.1, available at 

www.irs.gov/taxstats/indtaxstats/article/0,,id=134951,00.html. CBO estimated that $5 billion of 

that total was disallowed by the limitation on itemized deductions, leaving almost $332 billion that 

was ultimately deducted. BEA reports homeowners paid $351 billion in mortgage interest in 2002. 

See Department of Commerce, Bureau of Economic Analysis, “National Income and Product 

Account Tables,” Survey of Current Business, vol. 64, no.161 (August 2004), Table 7.11; available at 

http://bea.gov/bea/ARTICLES/2004/08August/0804NIPA_TABLES.pdf.

39. Omitted are health savings accounts (HSAs), which are even more tax favored, allowing pretax contributions and tax-free withdrawals (as long as they are applied to medical expenses). However, in 

2002—the year for which CBO collected most of its data—HSAs had not yet been introduced and 

no data were available for their much smaller predecessors, the Archer Medical Savings Accounts, 

which were replaced when HSAs became available in 2004.
50

The procedures outlined below treat all income from directly held corporate stocks as 

fully taxable but make a special adjustment to account for deferral when the marginal 

tax rate is applied to capital gains.

Noncorporate business owners and homeowners provide equity investments through 

their own saving. Consequently, the returns do not flow through to other savers 

whose tax status would have to be determined. The effective tax rate on those equity 

returns is captured by the computation of the before-tax return in equation (24) for 

noncorporate businesses and in equation (25) for owner-occupied housing.40 Thus, 

the taxation of those equity returns is not discussed further in this section.

Assumptions. The first task is to classify all household assets according to three criteria: the source of financing of the underlying investment, the business-entity-level tax 

treatment of the underlying investment, and the individual-level tax treatment of saving. By classifying assets on the basis of characteristics of the underlying investment, 

the CBO analysis departs from the usual practice of performing a single allocation of 

all household assets among individual-level tax treatments (frequently ignoring the 

“temporarily deferred” category). The desirability of abandoning that practice can be 

illustrated by examining how businesses with different organizational forms borrow. 

The biggest source of corporate borrowing is in bonds. Noncorporate businesses, in 

contrast, use primarily mortgages and bank loans. It is common for nontaxable 

accounts to hold corporate bonds, but it is less common for them to hold business 

mortgages or bank deposits. Thus, interest on corporate debt held by households is 

ultimately taxed at a lower average rate than is interest on noncorporate business debt.

Assets were allocated among the three categories of individual-level tax treatments in 

proportion to the distribution of assets in 2002. In general, marginal saving was distributed among those categories in proportion to assets. The exception was for assets 

in nontaxable accounts held by individuals who were constrained by a statutory contribution limit. For example, an IRA owner who contributes $5,000 annually cannot 

direct any marginal saving to that IRA because the statutory contribution limit is 

already met. Thus, it was necessary to divide the nontaxable category into groups designated as constrained and unconstrained. Plans in the constrained group have contribution limits that are binding on a significant percentage of participants. IRAs and 

401(k)-type retirement plans normally would make up this group, but the nature of 

the data makes it necessary to include all defined-contribution plans. Unconstrained 

plans have explicit or implicit contribution limits that only rarely are binding on participants. For purposes of this exercise, they are the defined-benefit plans.

Merely identifying total assets in each household tax treatment category is not 

sufficient, however. In the nontaxable–constrained category, contribution limits are 

40. Equation (24) accounts for the fact that the equity return from noncorporate businesses is fully taxable. Equation (25) accounts for the fact that the equity return from owner-occupied housing is 

not taxed although mortgage interest and property taxes are deductible for people who do itemize.
51

binding on some participants but not on others. To distribute marginal saving in the 

manner proposed, it was necessary to estimate the percentage of assets held by those 

for whom the limits are binding. CBO assumed that the marginal saving that would 

have been allocated to actually constrained accounts under a strictly proportional 

system was redirected to the fully taxable and temporarily deferred categories. The 

nontaxable–unconstrained category was not affected by the reallocation, because saving in defined-benefit plans is determined largely by employers and so is usually 

beyond the discretion of the taxpayer. To simulate alternative laws, CBO reestimated 

the percentage of assets held in nontaxable–constrained accounts by those for whom 

contribution limits are binding. Those assets were redirected to the fully taxable and 

temporarily deferred categories.

Identifying Household and Nonprofit Assets as Debt or Equity. Debt and equity 

instruments are not distributed the same way among the categories of accounts. 

Because different proposals affect debt and equity differently, it is important to be able 

to reflect those differences in the calculation of effective tax rates. Under current law, 

debt and equity are taxed differently when they fall into the “fully taxable” category.

The source of financing underlying household assets is straightforward in some cases 

but difficult to ascertain in others. The simplest to identify are the assets held directly 

by households, but assets also can be held indirectly in nontaxable, pass-through entities, such as mutual funds. Sometimes, the assets must be traced to identify the underlying source of financing. For example, some households hold part of their assets in 

private defined-contribution plans. Those plans, in turn, hold some assets in mutual 

funds. Finally, the mutual funds hold corporate equities and various credit market 

instruments. The debt–equity split for the mutual fund must be assigned back to the 

household.

Equity. Corporate equities held directly by households and nonprofits in 2002 were 

reported as $5,047.8 billion on line 16 of Flow of Funds Table L.100.a (see Table 6). 

Corporate equities held indirectly by households and nonprofits in 2002 were 

reported as $5,003.5 billion on line 8 of Table B.100.e. The vehicles in which equities 

are held indirectly include bank personal trusts and estates (Table B.100.e, line 9), life 

insurance companies (line 10), private defined-benefit pension funds (line 12), private 

defined-contribution pension funds (line 13), state and local government retirement 

funds (line 14), federal government retirement funds (line 15), and mutual funds 

(line 16).

Noncorporate equities in 2002 were reported as $5,139.7 billion on line 22 of Flow of 

Funds Table L.100. All were held directly. Equity in owner-occupied housing in 2002 

was reported at $7,791.9 billion on line 50 of Table B.100. Like noncorporate business equity, all was held directly by households.
52

Table 6.

Corporate Equity Held by Households and

Nonprofits, 2002

Source: Board of Governors of the Federal Reserve System, Flow of Funds Accounts of the United 

States (March 10, 2005), Tables B.100.e. and L.100.a, available at www.federalreserve.gov/

releases/z1/20050310.

Debt. The Flow of Funds report does not include a table that summarizes debt held 

both directly and indirectly by households. Instead, CBO compiled that information 

from various Flow of Funds tables (see Table 7). 

Debt held directly by households is reported on line 7 of Table L.100.a as “credit market instruments.” It is divided into open market paper (line 8), treasury securities 

(line 9), agency- and GSE-backed securities (line 12), municipal securities (line 13), 

corporate and foreign bonds (line 14), and mortgages (line 15). Treasury securities are 

excluded from the analysis because they are never issued by a taxable entity.

Debt held indirectly by households is more difficult to identify. Some is held directly 

by sectors whose liabilities are all assets of households. Those assets can simply be 

passed through to households. The sectors for which this is permissible, and the Flow 

of Funds table on which their credit market instrument holdings are reported, are 

bank personal trusts (Table L.116), private defined-benefit plans (Table L.119.b), private defined-contribution plans (Table L.119.c), state and local government retirement funds (Table L.120), and federal government retirement funds (Table L.121).

Other debt held indirectly by households is held directly by sectors whose liabilities 

are only partly assets of households. Those sectors, and the Flow of Funds tables on 

which their credit market instrument holdings are reported, are life insurance companies (Table L.117), money market funds (Table L.122), mutual funds (Table L.123), 

agency- and GSE-backed mortgage pools (Table L.126), commercial banks 

(Table L.109), savings institutions (Table L.113), and credit unions (Table L.115).

Directly Held 5,047.8

Indirectly Held

Bank personal trusts 385.0

Life insurance companies 692.5

Private defined-benefit plans 535.3

Private defined-contribution plans 1,076.0

State and local retirement plans 869.8

Federal retirement plans 45.9

Mutual funds 1,399.0 ________

Total 10,051.3

Dollars of Equity

Billions of 
53

Before attributing the credit market instruments held by those sectors to households, 

the appropriate share was identified. That was a straightforward exercise for several 

sectors:

B Table L.117 in the Flow of Funds report indicated that 87.7 percent of life insurance liabilities were either pension fund reserves or life insurance reserves, both of 

which are considered assets solely of households and nonprofits.

B All money market fund liabilities are money market fund shares. According to 

Table L.206, 48.8 percent of those shares were held by households or nonprofits. 

Therefore, 48.8 percent of each credit market instrument held by money market 

funds was attributed to the household and nonprofit sector. 

B All mutual fund liabilities are mutual fund shares. Because Table L.214 shows that 

63.9 percent of those shares were held by households or nonprofits, 63.9 percent 

of each credit market instrument held by mutual funds was attributed to the 

household and nonprofit sector.

B All agency- and GSE-backed mortgage pool liabilities are agency- and GSE-backed 

securities. According to Table L.210, 3.6 percent of those shares were held by 

households and nonprofits. Therefore, 3.6 percent of each credit market instrument held by agency- and GSE-backed mortgage pools was attributed to the 

household and nonprofit sector.

Deposits in commercial banks, savings institutions, and credit unions present another 

challenge in that they are not the only liability of depository institutions. Thus, only a 

portion of the debt held by depository institutions (67.1 percent) was passed through 

to other entities; the remainder was assumed to affect the value of corporate equities. 

Furthermore, according to Table L.205, sectors other than households and nonprofits 

held 37.0 percent of the passed-through deposits. Therefore, the share of each debt 

instrument held by depository institutions passed through to households and nonprofits was approximately 42.3 percent.

Finally, it was necessary to identify credit market instruments held indirectly by 

households and nonprofits through more than one level of pass-through entity. In 

addition to holding credit market instruments, several sectors also hold money market 

funds, mutual funds, agency- and GSE-backed securities, and deposits in financial 

institutions: life insurance companies, private defined-benefit plans, private definedcontribution plans, state and local retirement plans, federal retirement plans, and 

bank and personal trusts. 
54

Table 7.

Credit Instruments Held by Households and Nonprofits, 2002

(Billions of dollars)

Continued

98.9 200.5 585.6 706.8 0 0 103.6 34.0

Depository institutionsb 2.3 776.5 82.9 286.6 718.8 33.1 1,311.9 642.7

Money market fundsc 289.7 158.1 137.9 83.3 0 0 0 0

0 0 0 0 0 0 128.2 4.0

Bank personal trustse 11.4 34.2 100.9 35.6 0 0 2.3 0

Life insurance companiesf 64.9 290.3 17.5 1,271.6 0 92.2 4.1 215.2

Private defined-benefit plansg 16.3 181.5 0 231.5 0 0 1.2 3.4

Private defined-contribution plansh 23.6 39.0 0 75.8 0 0 1.6 4.2

State, local retirement plansi 45.5 151.8 0.5 334.5 0 0 6.8 14.5

Federal retirement plansj 0 5.5 0 2.8 0 0 0 0

Mutual fundsk 40.3 269.8 177.3 301.1 0 0 0 0

Bank personal trustsl

Depository institutions 0 2.2 0.2 0.8 2.0 0.1 3.7 1.8

Money market funds 14.5 7.9 0.2 0.8 0 0 0 0

Agency-, GSE-backed mortgage pools 0 0 0 0 0 0 21.9 0.7

Mutual funds 5.9 39.3 25.8 43.9 0 0 0 0

Life insurance companiesm

Depository institutions 0 6.1 0.6 2.3 5.7 0.3 10.4 5.1

Money market funds 37.5 20.5 17.8 10.8 0 0 0 0

Agency-, GSE-backed mortgage pools 0 0 0 0 0 0 185.6 5.8

Mutual funds 0.2 1.6 1.1 1.7 0 0 0 0

Private defined-benefit plansn

Depository institutions 0.1 26.7 2.8 9.9 24.7 1.1 45.1 22.1

Agency-, GSE-backed mortgage pools 0 0 0 0 0 0 116.1 3.6

Mutual funds 2.3 15.2 10.0 16.9 0 0 0 0

Private defined-contribution plans:o

Depository institutions 0 4.7 0.5 1.7 4.4 0.2 8.0 3.9

Money market funds 22.1 12.1 10.5 6.4 0 0 0 0

Agency-, GSE-backed mortgage pools 0 0 0 0 0 0 24.9 0.8

Mutual funds 8.1 53.9 35.4 60.2 0 0 0 0

Corporate

and Bank

AgencyDirectly Helda 

Other

Municipal

Securities

Foreign Loans, Loans and

Securities Bonds n.e.c.

and GSEBackedOpen

Market

Paper

Home Other

Advances Mortgages Mortgages

Agency-, GSE-backed mortgage poolsd

Indirectly Held (One pass-through entity)

Indirectly Held (Two pass-through entities)
55

Table 7.

Continued

(Billions of dollars)

Source: Congressional Budget Office based on Board of Governors of the Federal Reserve System, Flow of Funds Accounts of 

the United States (March 10, 2005), available at www.federalreserve.gov/releases/z1/20050310. The individual 

tables used are listed below.

Note: GSE = government-sponsored enterprise; n.e.c. = not elsewhere classified. 

a. Table L.100. 

b. Tables L.109, L.113, L.115, and L.205. 

c. Tables L.122 and L.206. 

d. Tables L.126 and L.210. 

e. Table L.116. 

f. Table L.117. 

g. Table L.119.b. 

h. Table L.119.c. 

i. Table L.120. 

j. Table L.121. 

k. Tables L.123 and L.214. 

l. Tables L.116, B.100.e, L.109, L.113, L.115, L.122, L.126, and L.123. 

m. Tables L.117, B.100.e, L.109, L.113, L.115, L.122, L.126, and L.123. 

n. Tables L.119.b, B.100.e, L.109, L.113, L.115, L.122, L.126, and L.123. 

o. Tables L.119.c, B.100.e, L.109, L.113, L.115, L.122, L.126, and L.123. 

p. Tables L.120, L.109, L.113, L.115, and L.126. 

q. Tables L.121 and L.126. 

State, local retirement plansp

Depository institutions 0 1.7 0.2 0.6 1.5 0.1 2.8 1.4

Agency, GSE-backed mortgage pools 0 0 0 0 0 0 97.1 3.0

Federal retirement plans and

Agency, GSE-backed mortgage poolsq 0 0 0 0 0 0 3.5 0.1 ______ _______ _______ _______ ______ ______ ________ ______

Total 683.4 2,299.0 1,214.5 3,488.9 757.1 127.1 2,078.9 966.2

Indirectly Held (Two pass-through entities), continued

Home Other

Paper Securities Securities Bonds n.e.c. Advances Mortgages Mortgages

Bank Other

Market Backed Municipal Foreign Loans, Loans and

Agency- Corporate

Open and GSE- and
56

Table 8.

Nonprofit Share of Assets and Liabilities, 2000

(Percent)

Source: Congressional Budget Office calculations based on Congressional Budget Office based on 

Board of Governors of the Federal Reserve System, Flow of Funds Accounts of the United 

States (March 10, 2005), Tables L.100 and L.100a, available at www.federalreserve.gov/

releases/z1/20050310.

Note: GSE = government-sponsored enterprise; n.e.c. = not elsewhere classified. 

The example of corporate bonds held by mutual funds that, in turn, are held by bank 

personal trusts illustrates how those amounts were estimated:

$339.1 billion Mutual fund holdings of bank personal trusts (Table L.116, line 14)

− $203.9 billion Equity portion of mutual fund holdings of bank personal trusts41

$135.2 billion Nonequity portion of mutual fund holdings of bank personal trusts

× 0.325 Corporate bond share of nonequity portion of all mutual funds42

$43.9 billion Corporate bond portion of mutual fund holdings of bank personal

trusts.

41. Derived as follows: $385.0 billion in corporate equity held indirectly by households through 

bank personal trusts (Table L.117, line 15), minus $181.0 billion in corporate equity held directly 

by bank personal trusts (Table B.100.e, line 9), equals $203.9 billion in corporate equity held 

indirectly (in mutual funds) by bank personal trusts.

42. Derived as follows: $470.9 billion in corporate bond holdings of mutual funds (Table L.123, line 

8), divided by $1,450.4 billion in nonequity holdings of mutual funds (Table L.123, line 11 minus 

line 9), equals 0.325 as the corporate bond share of nonequity holdings of mutual funds.

Time Deposits, Savings Deposits 0.4

Money Market Fund Shares 7.0

Open Market Paper 100.0

Agency-, GSE-Backed Securities 18.4

Municipal Securities 0.3

Corporate and Foreign Bonds 25.2

Mortgages 8.4

Corporate Equities 9.1

Mutual Fund Shares 1.4

Life Insurance Reserves 0

Pension Reserves 0

Investments in Bank Personal Trusts 0

9.7

2.8

7.5

Bank Loans, n.e.c.

Other Mortgages

Assets of Nonprofits as a Percentage of Assets of Households and Nonprofits

Liabilities of Nonprofits as a Percentage of Liabilities of All Issuers

Municipal Securities
57

Table 9.

Nonprofit Assets and Household Assets Distributed by 

Entity-Level Tax Treatment

(Billions of dollars)

Source: Congressional Budget Office calculations based on Board of Governors of the Federal 

Reserve System, Flow of Funds Accounts of the United States (March 10, 2005), available 

at www.federalreserve.gov/releases/z1/20050310; and Internal Revenue Service 

Statistics of Income data. 

Note: GSE = government-sponsored enterprise; n.e.c. = not elsewhere classified.

a. Includes debt issued by governments, nonprofits, foreign entities, pass-through entities, and 

households (except for home mortgages). 

Analogous calculations were performed for all credit market instruments held by the 

sectors in question. The amounts passing through life insurance companies were 

reduced to reflect the fact that only 87.7 percent of life insurance company liabilities 

are assets of households and nonprofits.

Removing Nonprofits from the Flow of Funds Data. It also was necessary to remove 

the assets of nonprofits from those reported in the Flow of Funds report’s Table L.100 

(assets of households and nonprofit organizations). In theory, that is accomplished by 

subtracting amounts held by nonprofits as reported on Table L.100.a. The March 

2005 release of that table, however, included data only through 2000. Therefore, nonprofit percentages for each asset were calculated for 2000 (see the top section of 

Table 8), then applied to the 2002 figures on Table L.100 (see the “Nonprofits” column of Table 9). The implication for indirectly held assets is that the nonprofit share 

is deemed to be that of the pass-through entity, not that of the corresponding asset 

when directly held by households and nonprofits. For example, 25.2 percent of 

563.7 497.4 7.5 0 119.7 683.4

securities 2,233.9 938.9 9.5 0 65.1 2,299.0

1,201.0 103.2 6.4 0 13.5 1,214.5

3,297.3 2,968.7 102.5 0 191.6 3,488.9

744.8 392.4 284.1 0 12.3 757.1

Other loans and 

advances 126.5 94.6 17.0 0 0.6 127.1

2,024.1 0 0 2,024.1 54.8 2,078.9

951.5 218.4 672.5 0 14.7 966.2 ________ _______ _______ _______ ______ ________

Total 11,142.7 5,213.5 1,099.4 2,024.1 472.3 11,615.1

9,543.3 9,084.3 459.0 0 508.0 10,051.3

Corporate bonds

Totala

Bank loans, n.e.c.

Equity

Corporate equities

Home mortgages

Other mortgages

Municipal securities

Households 

Nonprofits

Debt

Commercial paper

Agency-, GSE-backed 

Corporate Nonprofits

Households

Total, 

Housing

NoncorporateOccupied 

Owner-
58

corporate and foreign bonds held directly by households and nonprofits in 2000 were 

held by nonprofits. However, nonprofits held just 1.4 percent of mutual fund shares 

held by households and nonprofits, so only 1.4 percent of the corporate bonds held in 

mutual funds that were in turn held by households and nonprofits was attributed to 

nonprofits.

Allocating Assets Held by Households Among Business-Entity-Level Tax Treatments. 

Assets, regardless of ownership, were distributed among the corporate, noncorporate, 

and owner-occupied housing categories using largely the same data that were used to 

allocate marginal investments between debt and equity financing. The instrumentspecific tables from the Flow of Funds report used in that task to identify the liabilities 

of financial corporations (along with Table L.211, Municipal Securities) also were 

used to perform the initial allocation of those instruments among financial corporations, nonfinancial corporations, farms, and nonfarm noncorporate businesses.

Some assets fall into a “nontaxable” category. Debt instruments held directly or indirectly by households might have been issued by governments, nonprofits, foreign 

entities, pass-through entities, or other households—none of which (except home 

mortgages) enter into this analysis. The portion issued by nonprofits was estimated 

using the nonprofit amounts reported for 2000 on Table L.100.a (see the bottom section of Table 8). Otherwise, liabilities of nontaxable entities were taken from the 

instrument-specific tables listed in the previous section.

Allocation of assets between the corporate and noncorporate tax treatments differed 

for financial corporations, nonfinancial corporations, noncorporate nonfarm businesses, and farms. As above, 99.0 percent of the debt and 99.7 percent of the equity 

issued by financial corporations was assigned to the corporate treatment; the rest 

(attributable to S corporations) was assigned to the noncorporate category. For nonfinancial corporations, 94.2 percent of debt and 93.6 percent of equity was assigned 

to the corporate treatment. All noncorporate nonfarm business debt and equity was 

assigned to the noncorporate tax treatment. Farms were split, 6.5 percent corporate 

and 93.5 percent noncorporate. The resulting allocation is shown in the top section of 

Table 10; the percentage distribution of each debt instrument is shown in the bottom 

section of that table. 

Those percentages (derived from the way business liabilities are distributed between 

the corporate and noncorporate tax treatments) were then applied to the portion of 

debt and equity that was held as assets by households—smaller numbers (see the 

“Households Total” column of Table 9) than the liabilities from which the percentages were derived because they exclude amounts held as assets by entities that are 

not subject to the individual income tax (nonprofits, foreign entities, governments). 

Once each type of instrument had been distributed among entity-level tax treatments, 

the debt in each was added for all types of instruments (see “Total Households,
59

Table 10.

Distribution of Credit Market Instruments and Corporate 

Equities Outstanding, by Entity-Level Tax Treatment, 2002

Source: Congressional Budget Office calculations based on Board of Governors of the Federal 

Reserve System, Flow of Funds Accounts of the United States (March 10, 2005), available 

at www.federalreserve.gov/releases/z1/20050310; and Internal Revenue Service 

Statistics of Income data.

Note: GSE = government-sponsored enterprise; n.e.c. = not elsewhere classified.

a. Includes debt issued by governments, nonprofits, foreign entities, pass-through entities, and 

households (except home mortgages).

Nonprofits,” Table 9). The resulting amounts were then ready for distribution among 

individual-level tax treatments.

Allocating Assets Held by Households Among Individual-Level Tax Treatments. For 

the purpose of identifying marginal saving, household assets characterized as corporate equity, corporate debt, noncorporate debt, or owner-occupied housing debt must 

be classified as fully taxable, temporarily tax deferred, or nontaxable. The nontaxable 

category must be further divided on the basis of whether annual contributions to the 

accounts in question are limited for a significant proportion of participants (see 

1,209.0 18.3 0 147.4 1,374.7

0 0 0 3,609.8 3,609.8

2,326.9 23.5 0 3,185.9 5,536.3

151.5 9.3 0 1,602.3 1,763.1

5,383.2 185.8 0 410.1 5,979.1

706.2 511.3 0 122.9 1,340.4

1,103.6 198.0 0 174.3 1,475.9

0 0 5,909.5 0.0 5,909.5

550.6 1,695.8 0 152.8 2,399.2

10,082.0 443.9 0 1,345.1 11,871.0

88.2 1.3 0 10.4 100

0 0 0 100.0 100

42.0 0.4 0 57.5 100

8.6 0.5 0 90.9 100

90.0 3.1 0 6.9 100

52.7 38.1 0 9.1 100

74.8 13.4 0 11.8 100

0 0 100 0 100

23.0 70.7 0 6.4 100

84.9 3.7 0 11.3 100

Other Mortgages

Corporate Equities

Industrial Revenue Bonds

Corporate Bonds

Bank Loans, n.e.c.

Other Loans, Advances

Commercial Paper 

Treasury Securities

Agency-, GSE-Backed Securities

Home Mortgages

Other Loans, Advances

Home Mortgages

Other Mortgages

Corporate Equities

Asset

Billions of Dollars

Percent

Commercial Paper 

Treasury Securities

Agency-, GSE-Backed Securities

Industrial Revenue Bonds

Corporate Bonds

Bank Loans, n.e.c.

OwnerOccupied

Housing Othera Corporate corporate Total

 Non-
60

Table 11). Those identified as having binding contribution limits include IRAs and 

most defined-contribution retirement plans. Defined-benefit plans were identified 

as not having binding contribution limits because their implicit limits affect few 

participants.

In many cases, the assignment was straightforward. Assets passed through private 

defined-contribution plans were assigned to the nontaxable–constrained category. 

Assets passed through private defined-benefit plans, state and local pension plans, and 

federal pension plans were assigned to the nontaxable–unconstrained category. Assets 

passed through bank personal trusts and agency- and GSE-backed mortgage pools 

were assigned to the fully taxable category.

Directly held assets and those passing through depository institutions, money market 

funds, mutual funds, and life insurance companies can all be held in IRAs, which fall 

into the nontaxable–constrained category. Directly held amounts and the amounts 

passing through the other entities are reported in the Flow of Funds Table L.225.i. 

Those amounts were subdivided into equity and specific debt instruments in proportion to the holdings of the pass-through entity. For example, because 20 percent of the 

assets of life insurance companies were equities (after redistributing mutual fund 

shares), 20 percent of IRA assets held at life insurance companies also were assumed to 

be equities.

Except for amounts attributed to IRAs, directly held assets and assets that pass 

through depository institutions, money market funds, and mutual funds were 

assigned to the fully taxable category. Non-IRA assets passing through life insurance 

companies cause more complications. Some assets are held in group annuities purchased by qualified plans and therefore are nontaxable. The rest are held in nonqualified annuities and whole-life insurance policies and therefore are temporarily 

deferred. The Flow of Funds report does not distinguish between the two categories. 

Instead, Table 8.2 of the Life Insurers Fact Book 2004 provided data for an estimate of 

the amount held in group annuities.43 That amount was assigned to the nontaxable–

unconstrained category and divided between equity and specific debt instruments in 

proportion to the overall holdings of life insurance companies. The remaining nonIRA assets were assigned to the temporarily deferred category and similarly divided 

between equity and specific debt instruments.

Adjusting the Distribution of Assets to Reflect Marginal Saving. The number of families constrained by contribution limits and their share of marginal saving initially was 

estimated with microdata from the 2001 Survey of Consumer Finances (SCF),44

43. American Council of Life Insurers, Life Insurers Fact Book 2004, available at www.acli.com/ACLI/

About+ACLI+nonmember/Industry+Facts/NM03-01+Fact+Book.htm.

44. The 2001 Survey of Consumer Finances and its accompanying documentation are available at 

www.federalreserve.gov/pubs/oss/oss2/2001/scf2001.information.html.
61

Table 11.

Assets Held by Households, by Individual-Level

Tax Treatment, 2002

(Billions of dollars)

Source: Congressional Budget Office calculations and Board of Governors of the Federal Reserve 

System, Flow of Funds Accounts of the United States (March 10, 2005), available at 

www.federalreserve.gov/releases/z1/20050310.

Note: IRA = individual retirement account; GSE = government-sponsored enterprise.

a. Excluding amounts held in IRAs.

b. Held in IRAs. Self-directed IRAs are counted as “directly held.”

3,751.1 533.6 37.4 83.9

0 1,049.6 683.7 1,203.1

0 284.8 5.5 0

0 0.7 2.3 104.6

357.6 152.4 6.7 27.9

813.5 272.5 7.5 0 ______ ______ _____ ______

Total 4,922.1 2,293.7 743.0 1,419.6

487.4 1,061.2 152.7 140.7

617.8 69.9 4.9 11.0

0 75.2 49.0 86.2

0 95.4 1.8 0

479.7 156.8 4.3 0

60.3 157.5 22.7 20.9

1,024.3 231.8 13.9 34.8

______ _____ ____ _____

Total 2,182.1 786.5 96.6 152.6

111.5 291.1 41.9 38.6

509.6 364.5 39.4 162.4

828.0 411.6 25.6 106.7

43.7 4.9 0.2 3.5 ______ ______ _____ _____

Total 1,492.7 1,072.1 107.1 311.2

9,084.3 5,213.5 1,099.4 2,024.1

All Tax Treatments

Total

Federal retirement plans

Indirectly Held Through

Life insurance companies 

(Group annuities)

Life insurance companiesb 

Private defined-contribution plans

Private defined-benefit plans

State, local retirement plans

Indirectly Held Through

Depository institutionsb 

Money market fundsb 

Mutual fundsb 

Companies (Nonqualified annuities 

and whole-life policies)

Nontaxable–Constrained

Directly Heldb

Bank personal trusts

Mutual fundsa

Temporarily Deferred

Indirectly Held Through Life Insurance 

Indirectly Held Through

Depository institutionsa 

Money market fundsa 

Agency-, GSE-backed mortgage pools

Occupied

 Housing Debt

Fully Taxable

Directly Helda

Nontaxable–Unconstrained

OwnerEquity

Corporate Corporate

Debt

Noncorporate

Debt
62

which covered assets accumulated before the enactment of the Economic Growth and 

Tax Relief Reconciliation Act of 2001 (EGTRRA). For this exercise, however, marginal saving was assumed to occur in a tax environment in which EGTRRA was in 

place and extended indefinitely. The 2004 SCF was not available when the study was 

conducted; thus, CBO adjusted the 2001 data to reflect EGTRRA, as described 

below. Furthermore, the 2001 SCF did not include IRA contributions, so they were 

imputed on the basis of percentages calculated with CBO’s individual income tax 

model. Marginal saving was assumed to be distributed in proportion to the sum of 

capital income and 401(k) contributions.45

According to the SCF, 46 percent of marginal saving was done by families constrained 

by IRA or 401(k) contribution limits. Their saving was reshuffled so that the amount 

that ordinarily would have been assigned to the constrained account was redirected to 

the fully taxable and temporarily deferred groups. The distribution among groups was 

left unchanged for the 54 percent of marginal saving done by families that were not 

constrained by a limit.

Consider, for example, saving in corporate equity.46 Approximately 40 percent of the 

return on such assets was nontaxable (24 percent in accounts with binding limits, 

16 percent in accounts without binding limits), 5 percent was temporarily deferred, 

and 54 percent was fully taxable (see Table 12, “Assets” column).

45. An alternative assumption would be that marginal saving is proportional to average saving. Empirical data on average saving, however, are too incomplete to justify the extra effort of their processing. A panel from the 1983 and 1989 Surveys of Consumer Finances (see www.federalreserve.gov/

Pubs/oss/oss2/89p/scf89phome.html) is too old to be useful, panels from the Survey of Income 

and Project Participation (see www.sipp.census.gov/sipp/) are too short-lived, the Panel Study of 

Income Dynamics (see http://psidonline.isr.umich.edu/data/) is hindered by top-coding, and the 

Consumer Expenditure Survey (see www.bls.gov/cex/csxmicro.htm) yields implausibly high rates 

of “dissaving” at the lower end of the income distribution. The two items used to distribute marginal saving are both plausible proxies for the propensity to save—capital income because it implies 

that saving has occurred in the past, and 401(k) contributions because they imply current saving 

(unless the contributions represent shifting from taxable accounts, in which case they imply saving 

in the past). In the absence of more precise data, the two proxies were arbitrarily combined.

46. Similar procedures were followed for corporate debt, noncorporate debt, and owner-occupiedhousing debt. The results are shown in Table 12.
63

Table 12.

Distribution of Assets and Percentage of Marginal Saving 

Exempted or Deferred

(Percent)

Source: Congressional Budget Office.

a. 2002 shares based on Board of Governors of the Federal Reserve System, Flow of Funds 

Accounts of the United States (March 10, 2005), available at www.federalreserve.gov/releases/

z1/20050310.

b. The base case assumes that the tax provisions in place in 2008 under the Economic Growth and 

Tax Relief Reconciliation Act of 2001 and the Jobs and Growth Tax Relief Reconciliation Act of 

2003 are permanently extended instead of expiring in 2011.

Equations in Table 13 show how that distribution of assets was used to distribute 

marginal saving among those groups—for the constrained and unconstrained families 

separately—then reaggregated. Note that the 24 percent of assets in the nontaxable–

binding limits category for unconstrained families was split between “Temporarily 

Deferred” (2 percent) and “Fully Taxable” (22 percent) for constrained families.

Corporate Equity

Fully taxable 54.2 58.4 64.2

Temporarily tax deferred 5.4 5.8 6.4

Nontaxable 40.4 35.8 29.4

Corporate Debt

Fully taxable 43.9 45.9 48.7

Temporarily tax deferred 20.4 21.3 22.5

Nontaxable 35.7 32.8 28.8

Noncorporate Debt

Fully taxable 67.6 69.1 70.9

Temporarily tax deferred 13.9 14.2 14.6

Nontaxable 18.5 16.7 14.5

Homeowner Debt

Fully taxable 70.0 71.6 73.3

Temporarily tax deferred 7.0 7.1 7.3

Nontaxable 23.0 21.3 19.4

Base Caseb After 2010

Marginal Saving

Current Law

Assetsa
64

Table 13.

Distribution of Marginal Saving for Families 

Constrained and Unconstrained by Contribution Limits

Source: Congressional Budget Office.

The higher contribution limits under EGTRRA had to be incorporated to represent 

the base case. Implementing the exception to the general rule under such circumstances required estimating how saving would have been distributed under those 

higher limits. First, unconstrained contributions to 401(k) plans were estimated on 

the basis of an age-specific percentage of income, then reestimated as though the 

EGTRRA limits had been in place. Next, IRA contributions in 2002 were estimated 

on the basis of actual IRA deductions reported in 2002, then extrapolated to represent 

unconstrained contributions and those under the fully-phased-in EGTRRA limits. 

Under EGTRRA, the percentage of marginal saving by families constrained by a limit 

dropped from 46 percent to 29 percent, which was redistributed so that amounts that 

would otherwise have been saved in constrained accounts were directed to fully taxable or temporarily deferred accounts. That left 17 percent to switch from the constrained to the unconstrained category. It was estimated that the higher limits under 

EGTRRA would stimulate a 55 percent increase in contributions to nontaxable 

accounts, so the existing distribution of assets among the groups was adjusted to shift 

that amount from the fully taxable and temporarily deferred groups into the nontaxable group. The remaining 54 percent of marginal saving was unaffected by 

EGTRRA, so its distribution among groups did not change.

Identifying the Marginal Tax Rate for Individuals. Although the actual marginal individual income tax rate that would apply to a particular investment depends on the 

stock- or bondholder’s marginal tax bracket, CBO assumed that the average marginal 

tax rate would apply to all investments. Such rates were estimated for each type of 

investment income using CBO’s individual income tax model. In some cases, additional parameters had to be specified in order to calculate the effect of tax deferral on 

the effective rate.

Interest. The marginal rate at which interest in taxable accounts was assumed to be 

taxed, tint, was 22.1 percent. That reflects a weighted average of the regular marginal 

rates of all taxpayers reporting taxable interest income. 

Unconstrained Constrained Total

Nontaxable–Binding Limits (0.54 × 0.24) + (0.46 × 0) = 0.13

Nontaxable–No Binding Limits (0.54 × 0.16) + (0.46 × 0.16) = 0.16

Nontaxable subtotal, αce1 = 0.29

Temporarily Tax Deferred, αce2 (0.54 × 0.05) + [0.46 × (0.05 + 0.02)] = 0.06

Fully Taxable, αce3 (0.54 × 0.54) + [0.46 × (0.54 + 0.22)] = 0.64
65

Table 14.

Parameters Affecting the Taxation of Capital Gains

Source: Congressional Budget Office. 

Note: n.a. = not applicable.

Dividends. The marginal rate at which dividends in taxable accounts were assumed to 

be taxed, tdiv, was 12.1 percent. That rate is substantially lower than the rate on interest, not because the taxpayers receiving dividends were in lower regular tax brackets, 

but because dividends are subject to a maximum 15 percent rate.

Capital Gains. Three tax rates can be applied to capital gains, depending on the holding period. The short-term rate, tscg, applies to gains on assets held for less than one 

year. The long-term rate, tlcg, applies to gains on assets held for more than one year 

but sold before the owner’s death. Capital gains on assets held until the owner’s death 

are not taxed, so that rate is zero.

As explained in the section on methodology, deferring the taxation of capital gains 

from the time gains accrue until a stock is sold causes the effective tax rate on those 

gains to diverge from the statutory tax rate. Inflation makes the effective tax rate rise, 

and delay in paying the tax causes the effective tax rate to fall. CBO incorporates those 

influences by computing effective tax rates on capital gains for average short-term and 

long-term holding periods. The average holding periods, Yscg and Ylcg, and the corresponding short- and long-term fractions of gains were estimated using the 1998 SOI 

study of the sale of capital assets.47 CBO estimated the statutory average marginal tax 

rates using positive gains reported by returns with positive income (see Table 14).

As with dividends, the lower marginal tax rate on long-term capital gains reflects the 

15 percent maximum rate. Short-term capital gains are taxed at regular rates. Equations (46) through (48) show how the capital gains parameters were applied in CBO’s 

analysis.

Annuity Distributions. Distributions from temporarily deferred accounts are reported 

as pension distributions and taxed at regular rates, even if they reflect deferred dividends or long-term capital gain income. Because there is no way to distinguish such 

Percentage of

All Gains (ω)

Holding Period 

(Y)

Marginal Tax Rate 

(t)

Short Term, scg 3.6 4 months 28.0

Long Term, lcg 48.2 8 years 14.5

Held Until Death, xcg 48.2 n.a. 0

47. Janette Wilson, “Sales of Capital Assets Reported on Individual Income Tax Returns, 1998 and 

1997,” Statistics of Income Bulletin (Summer 2002), p. 168, available at www.irs.gov/pub/irs-soi/

98insoca.pdf.
66

Table 15.

Economic Depreciation Rates and Tax Depreciation

Parameters

Continued

distributions from other pension distributions, the average marginal rate on all pension distributions was applied to distributions from temporarily deferred accounts. 

That rate, ttd, was estimated to be 20.9 percent.

By definition, those distributions benefit from tax deferral, and the benefit increases 

with the holding period. The average holding period, Ytd, was assumed to be eight 

years.

Specifying Economic Depreciation Rates and Tax Depreciation Allowances

For a particular asset type, the before-tax rate of return required by an investment, ρ, 

depends on the rate at which the asset’s economic productivity depreciates, δ, and the 

present value of the depreciation allowance, z, allowed by the tax code. To calculate 

before-tax returns for the 49 asset types, therefore, it was necessary to identify rates of 

economic depreciation and present values of tax depreciation for each type.

Asset

0.4633 5 DB (200)

0.4400 3 SL 

0.1129 7 b DB (200)

0.1350 7 b DB (200)

0.1350 7 b DB (200)

0.1800 5 c DB (200)

0.3119 5 c DB (200)

0.1375 5 c DB (200)

0.1179 7 DB (200)

0.1650 5 c DB (200)

0.1500 5 DB (200)

0.3333 5 DB (200)

0.1725 5 DB (200)

0.1725 5 DB (200)

0.0859 5 d DB (200)

0.0611 10 c DB (200)

0.0589 7 DB (200)

0.1225 7 b DB (200)

0.1031 7 b, e DB (200)

Equipment

Computers, Peripheral Equipment

Software

Ships, Boats

Railroad Equipment

Metal-Working Machinery

Special Industrial Machinery

Automobiles

Light Trucks (Including utility vehicles)

Other Trucks, Buses, Truck Trailers

Aircraft

Communications Equipment

Medical Equipment, Instruments

Nonmedical Instruments

Photocopiers, Related Equipment

Office, Accounting Equipment

Household Furniture

Methoda

Economic Default 

Depreciation

Rate

Depreciation

(Years)

Default

Recovery

Period

Other Furniture

Household Appliances

Residential Equipment
67

Table 15.

Continued

Continued

Economic Depreciation Rates. CBO used BEA’s published economic depreciation 

rates (see Table 15).48 BEA does not treat land or inventories as depreciable assets, nor 

did CBO. For the remaining 47 types of assets, the rates published by BEA are those 

BEA uses to convert historical acquisition costs into current capital stocks by asset 

type. Thus, the economic depreciation rates used in CBO’s calculations are consistent 

with the distribution of BEA’s capital stock that CBO used to aggregate asset-typespecific, before-tax rates of return, ρ, in equations (59) and (61).

48. Department of Commerce, Bureau of Economic Analysis, Fixed Assets and Consumer Durable 

Goods in the United States, 1925–97 (September 2003), Table B, p. M-30; Table C, pp. M-31–

M-32; available at www.bea.gov/bea/dn/Fixed_Assets_1925_97.pdf.

0.1179 7 DB (200)

0.1452 7 DB (200)

0.1550 5 c DB (200)

0.1633 5 c DB (200)

0.1500 7 DB (200)

0.1528 7 b DB (200)

0.0917 7 b DB (200)

0.1072 7 DB (200)

0.0516 15 c,f DB (150) f, g

0.2063 7 DB (200)

0.0500 15 c, h DB (150) g

0.1834 7 b DB (200)

0.1473 7 b DB (200)

0.0144 n.a. n.a.

0.0163 27.5 SL 

0.0167 27.5 SL 

0.0247 39 SL 

0.0261 39 i SLi

0.0188 39 SL 

0.0314 39 SL 

0.0188 39 SL 

Rate (Years) Methoda

Structures

Educational Buildings

Manufacturing Buildings

Owner-Occupied Residential Structures

Tenant-Occupied Residential Structures

Corporate-owned

Agricultural Machinery

Hospitals, Special Care Facilities

General Industrial Equipment

Recovery

Asset

Equipment (Continued)

Other Nonresidential Equipment

Steam Engines

Internal Combustion Engines

Electric Transmission, Distribution 

Other Electrical Equipment

Equipment

Default 

Service Industry Machinery

Fabricated Metal Products

Farm Tractors

Construction Machinery

Construction Tractors

Mining, Oilfield Machinery

Office Buildings, Including Medical

Commercial Buildings

Depreciation Period Depreciation

Noncorporate-owned

Default

Economic
68

Table 15.

Continued

Source: Congressional Budget Office based on Department of Commerce, Bureau of Economic 

Analysis, Fixed Assets and Consumer Durable Goods in the United States, 1925–97

(September 2003); and Department of the Treasury, Internal Revenue Service, Publication 

946, How to Depreciate Property, For Use in Preparing 2004 Returns.

Notes: DB = declining balance; SL = straight line; n.a. = not applicable. In the farm industry, all 

assets except software use the 150 percent DB method and the recovery period is capped at 

20 years.

a. Numbers in parentheses are DB percentages.

b. In the professional, scientific, and technical services industry, the recovery period is five years.

c. In the amusement, gambling, and recreation services industries, the recovery period is seven 

years.

d. In the air, rail, and water transportation industries; the finance industry; and the non-real-estate 

rental and leasing industry, the recovery period is seven years. 

e. In the plastics, rubber, glass products, and transportation equipment manufacturing industries, 

the recovery period is three years. In the construction, chemical manufacturing, nonmetallic 

mineral products manufacturing, and computer and electronic products manufacturing industries, the recovery period is five years. In the textiles and apparel manufacturing industries, the 

recovery period is evenly weighted between five and seven years. In the petroleum and coal 

products manufacturing industries, the recovery period is 10 years.

f. In the paper products manufacturing industry, the recovery period is seven years and the 200 

percent DB method is used.

g. In the amusement, gambling, and recreation services industry, the 200 percent DB method is 

used.

h. In the utilities industry, the recovery period is 20 years.

i. In the retail trade industry, 5 percent of assets use the 150 percent DB method; a recovery 

period of 15 years is used.

j. In all industries, 60 percent of assets have a recovery period of 20 years and 40 percent have a 

recovery period of 15 years.

k. Except for the pipeline transportation industry, see note j. In pipeline transportation, the 

recovery period is 15 years.

0.0259 39 c SLg 

0.0751 5 DB (200)

0.0450 7 DB (200)

0.0211 20/15 j DB (150)

0.0237 20/15 k DB (150)

0.0237 15 DB (150)

0.0213 20 DB (150)

0.0239 20 DB (150)

0.0225 39 SL 

Methoda

Default

Economic Recovery Default 

Other Power Structures

Electric Power Structures

Mining Structures

Depreciation Period Depreciation

Asset Rate (Years)

Petroleum, Natural Gas

Other Buildings

Structures (Continued)

Railroads

Farm Structures

Other Nonresidential Structures

Communication Structures
69

For 35 of the 47 asset types, BEA reported a single geometric depreciation rate that 

CBO used directly. For the remaining 12, BEA published more detailed rates, which 

CBO aggregated by a variety of methods.

Asset Types with Depreciation Rates That Vary by Industry. BEA’s depreciation rates 

varied by industry for five asset types: communications equipment, aircraft, service 

industry equipment, commercial buildings, and other buildings. Because BEA’s capital stocks for each asset type were distributed by industry, CBO used those industry 

distributions to compute weighted averages of the depreciation rates for each asset 

type.

Residential Housing. BEA published six depreciation rates by structure size and asset 

type. Two structure sizes were identified: those with one to four units and those with 

five units or more. Three asset types were identified: new construction, additions and 

alterations, and major replacements. BEA also published separate depreciation rates 

for manufactured homes and residential equipment. BEA publishes capital stocks 

with the same categories for several forms of ownership that CBO combined into 

owner-occupied, corporate, and noncorporate ownership. Combining the depreciation rates and capital stocks, CBO computed weighted-average depreciation rates for 

structures by each form of ownership.49 The rates varied by type of owner because the 

distributions of structure types and sizes differed by form of ownership. Residential 

equipment was retained as a separate type of asset.

Asset Types with Depreciation Rates That Vary by Asset Characteristic. BEA publishes 

depreciation rates by subcategories of four asset types for which it does not publish 

corresponding subcategories of capital stocks. Therefore, CBO aggregated the depreciation rates within each asset type, using measures of central tendency as follows:

B Software was aggregated using a simple average of the rates for “packaged software” 

and “custom and own-account software.”

B The asset type “light trucks (including utility vehicles)” and the type “other trucks, 

buses, and truck trailers” were assigned to the middle of three relevant depreciation 

rates given by BEA—the one that applies to the trucking industry.

B Railroad structures were aggregated using a simple average of the rates for “rails” 

and “other structures.”

49. CBO’s error of including the small amount of owner-occupied farm structures as tenant-occupied, 

noncorporate structures, noted in footnote 22, caused small errors in average depreciation rates. 

The average rate for owner-occupied structures should have been 0.0145 instead of 0.0144. 

Correcting the error does not affect the average for tenant-occupied structures owned by corporations (0.0163), but it reduces the average for tenant-occupied structures owned by noncorporate 

businesses from 0.0167 to 0.0164.
70

Automobiles and Computers and Peripherals. BEA has determined that depreciation 

rates for these two asset categories vary during the lives of the assets. The formulas for 

before-tax returns, as in equation (23), require a constant rate of depreciation over an 

asset’s life. CBO averaged BEA’s rates over the life of an asset to arrive at a single 

geometric rate.

B A constant geometric depreciation rate of one-third for automobiles was previously 

estimated by Charles Hulten and Frank Wycoff.50 Because that rate approximated 

the varying rates used by BEA, CBO adopted one-third.

B BEA provides time-changing rates for two types of computers and five types of 

peripherals. CBO observed that the depreciation schedules for the computers were 

similar and the schedules for the peripherals were similar, so it used one of each: 

personal computers, to represent the former, and printers, to represent the latter. 

CBO averaged the yearly depreciation rates for personal computers to arrive at a 

single geometric rate, and it repeated the averaging for printers. In both cases, 

BEA’s annual depreciation was below average in the first year of use and above 

average in the last, but otherwise it fluctuated around the average rate. To arrive at 

a single depreciation rate for the category, CBO averaged the average rates for 

personal computers and printers, weighting personal computers by two-thirds 

because of the assumption that spending on computers was about twice that on 

peripherals.

Present Values of Tax Depreciation Allowances. The formulas for computing present 

values under current law are shown in equations (28) and (34), and the computed 

present values for corporate assets are shown in the “Tax Depreciation” column of 

Table 16. Present values depend on the discount rate of the business or homeowner 

making the investment and on parameters established by the tax code for each asset 

type. The parameters from the code are explained in IRS Publication 946, How to 

Depreciate Property.

51 Most depreciable business assets are depreciated according to 

the modified accelerated cost recovery system, known as MACRS. That system identifies nine property classes and three depreciation methods. The depreciation schedule 

for an asset is largely determined by the particular combination of a class and a 

method.

Eight of the property classes applied to the BEA assets. Those were recovery periods of 

3, 5, 7, 10, 15, and 20 years; residential rental property (27.5 years); and nonresidential real property (39 years). The three depreciation methods are 200 percent declining balance, 150 percent declining balance, and straight line. The declining-balance 

methods include a switch to straight-line depreciation in the first year in which the

50. Hulten and Wycoff, “The Measurement of Economic Depreciation,” p. 95.

51. CBO used IRS Publication 946 for tax year 2004.
71

straight-line method gives a comparable or better depreciation allowance. Publication 

946 provides general guidance and numerous examples to help taxpayers decide 

which class and method to apply to any particular asset. Thus, CBO’s task was to follow that guidance with each of its 47 depreciable asset categories (see Table 15). The 

tax code does not provide depreciation allowances for land or inventories.

CBO faced considerable ambiguity in assigning classes and methods to some types of 

assets. Part of the difficulty arose because several BEA asset types do not fit clearly into 

a single MACRS class. For example, BEA’s electric power structures are not divided 

into nuclear and conventional power plants, but Publication 946 identifies a 15-year 

recovery period for nuclear plants and a 20-year recovery period for conventional 

power plants. Additional difficulty arose because many assets can qualify for different 

MACRS classes and methods, depending on use. Steam engines, for example, generally appear to qualify for 15-year depreciation under the 150 percent decliningbalance method. Steam engines used in the manufacture of pulp and paper, however, 

qualify for seven-year recovery with the 200 percent declining-balance method. 

CBO resolved some ambiguity about asset classes and methods by using BEA’s distribution of each asset’s capital stock among many industries. It was thus possible to 

account for some of the differences by activity that are identified in IRS Publication 946. In retrospect, greater use could have been made of industry-specific 

classifications. CBO resolved other ambiguities by following previously published 

assignments.52

When a single BEA asset category had more than one set of depreciation allowances, 

CBO computed the present value of each and averaged them with weights in proportion to the share of the capital stock of that asset using each method. For some asset 

types, such as structures used in the generation of electricity, the BEA data were not 

sufficient to calculate a weight for each component. In those cases, CBO used weights 

from the earlier publications.

CBO’s analysis ignored two temporary modifications of MACRS. Between October 

22, 2004, and January 1, 2006, owners of nonresidential buildings could depreciate 

some improvements for tenants on an accelerated schedule—over 15 years instead of 

39 years—and owners of restaurants could depreciate building improvements on the 

same schedule. CBO ignored those modifications because of the short time they were 

available and because there was insufficient information from BEA about which 

improvements would qualify.

Publication 946 explains that the appropriate tax depreciation schedule includes an 

adjustment to approximately account for the time within a year that an asset is placed 

in service. CBO’s depreciation schedules are continuous-time analogues to the tax 

depreciation schedules used in practice, and they fully adjust for starting dates within 

52. Fullerton, Gillette, and Mackie, “Investment Incentives,” pp. 135–140; Gravelle, The Economic 

Effects of Taxing Capital Income, pp. 296–298; Mackie, “Unfinished Business,” p. 308.
72

Table 16.

Present Values of Economic Depreciation and 

Tax Depreciation of Corporate Assets

(Percentage of acquisition cost) 

Continued

a calendar year. CBO used continuous-time formulas because they are more consistent with the formulas it used to compute before-tax rates of return.

Specifying Rates of Return

The formulas in the methodology section for computing the before-tax and after-tax 

returns on investments require values for i, the market interest rate, and E, the rate of 

return corporations pay to equity investors. CBO selected values that are observable 

in capital markets for corporations, and it held them fixed through all alternative tax 

policies.

89.7 87.0

89.2 90.1

68.0 82.6

71.8 82.5

71.8 82.8

77.2 87.0

85.5 87.0

72.1 87.0

68.9 82.5

75.7 87.0

73.9 87.0

86.3 87.0

76.5 87.0

76.5 87.0

61.8 82.8

53.5 76.5

52.6 82.5

69.8 82.5

66.0 84.4

68.9 80.9

73.2 81.4

74.5 87.0

75.5 87.0

73.9 82.5

74.2 82.5

63.3 82.5

Asset Economic Depreciation Tax Depreciation

Computers, Peripheral Equipment

Software

Communications Equipment

Equipment

Medical Equipment, Instruments

Nonmedical Instruments

Photocopiers, Related Equipment

Office, Accounting Equipment

Household Furniture

Other Furniture

Household Appliances

Residential Equipment

Automobiles

Light Trucks (Including utility vehicles)

Other Trucks, Buses, Truck Trailers

Aircraft

Ships, Boats

Railroad Equipment

Metal-Working Machinery

Special Industrial Machinery

Agricultural Machinery

Farm Tractors

Construction Machinery

Construction Tractors

Mining, Oilfield Machinery

Service Industry Machinery

Fabricated Metal Products
73

Table 16.

Continued

(Percentage of acquisition cost)

Source: Congressional Budget Office.

Notes: n.a. = not applicable.

Present values are computed assuming 41 percent debt finance.

The market interest rate CBO selected was the Baa corporate bond rate of 7.2 percent 

that CBO forecast in January 2005 for the intermediate term.53 The selected return 

on corporate equity was the long-term historical real rate of return on corporate 

equities of about 7 percent, of which about 4 percentage points typically has been 

paid out in dividends; the other 3 points generally have been retained and reinvested

53. That is an unpublished rate from the forecast used in Congressional Budget Office, The Budget and 

Economic Outlook: Fiscal Years 2006 to 2015 (January 2005).

66.9 82.5

49.3 64.5

79.5 82.5

Equipment 48.5 60.4

77.5 82.8

73.5 82.6

21.3 n.a.

23.5 43.9

n.a. 43.9

31.7 33.8

33.0 34.5

26.1 33.8

37.2 33.8

26.1 33.8

32.8 33.8

58.6 87.0

45.9 82.5

28.4 59.4

30.9 60.1

30.9 64.0

28.6 56.3

31.0 56.3

29.8 33.9

Equipment (Continued)

Structures

 Economic Depreciation Tax Depreciation

Internal Combustion Engines

Electric Transmission, Distribution

Other Electrical Equipment

General Industrial Equipment

Asset

Steam Engines

Noncorporate-owned

Other Nonresidential Equipment

Owner-Occupied Residential Structures

Tenant-Occupied Residential Structures

Corporate-owned

Office, Including Medical Buildings

Commercial Buildings

Hospitals, Special Care Facilities

Manufacturing Buildings

Educational Buildings

Other Buildings

Petroleum, Natural Gas

Railroads

Farm Structures

Other Nonresidential Structures

Mining Structures

Electric Power Structures

Other Power Structures

Communication Structures
74

Table 17.

Real Rates of Return and Rate of Inflation

(Percent)

Source: Congressional Budget Office based on The Budget and Economic Outlook: Fiscal Years 

2006 to 2015 (January 2005) and Siegel, Stocks for the Long Run.

(see Table 17).54 CBO assumed that distribution pattern for its computations of 

effective tax rates. The 7.2 percent market interest rate was converted to a 5.4 percent 

real interest rate by subtracting CBO’s intermediate-term inflation rate of 1.8 percent; 

the real return on equities was converted to a nominal rate by adding that inflation 

rate. The real return on 10-year Treasury bonds from the same forecast was lower, at 

3.7 percent, reflecting their lower risk of default.

The observed rates of return in the corporate sector were extended to the noncorporate and homeowner sectors. Specifically, noncorporate businesses and homebuyers were assumed to borrow for their marginal investments at the same Baa rate 

that applies to corporations. Savers investing their marginal dollars of equity in their 

own businesses or homes were assumed to receive the same after-tax return they 

would receive from investing in corporate equity.

The process by which interest rates and rates of return on corporate equity adjust to 

changes in tax policies is too complicated to be incorporated into the computation of 

effective tax rates. For simplicity, CBO decided to fix the interest rate and the return 

on corporate equity. Nevertheless, interest rates and rates of return on corporate

54. Jeremy J. Siegel, Stocks for the Long Run (New York: McGraw-Hill, 1998), pp. 12–13. Siegel’s 

historical 7 percent real rate of return on corporate equities is similar to that implicit in the CBO 

forecast. His estimated division of the return between dividends and retained earnings, based on 

dividend price ratios reported by companies, appears to differ from the division reported by BEA in 

Table 1.12, “National Income by Type of Income,” of the national income and product accounts, 

as revised April 28, 2005. When CBO adjusted the national accounts data to isolate C corporations, about 3/7 of after-tax profits was paid out in dividends; the rest was retained. CBO found no 

explanation for the discrepancy between the two sources.

Real Rate of Return

10-year Treasury bonds 3.7

5.4

7.0

Return paid out as dividends 4.0

Return reinvested 3.0

Rate of Inflation 1.8

Baa corporate bonds

Corporate stocks
75

equity should be expected to change as the economy adjusts to policy changes.55

Those adjustments would alter the effective tax rates CBO computes, but they should 

not change the qualitative implications discussed in Taxing Capital Income.

Other assumptions identified earlier also are simplifications to facilitate the computation of effective tax rates, and they are likely to change as the economy adjusts to tax 

policy changes. Two examples are the assumption that marginal investments are 

financed by debt and equity in the same proportion as are existing financing

arrangements and the assumption that marginal investments are distributed in proportion to the existing mix of capital stock. Many tax policies would be expected to 

change one or both of those assumptions.

CBO’s assumption of fixed interest rates and rates of return on corporate equity has 

been used in previous studies of effective tax rates. Gravelle, for one, also assumed 

interest rates and rates of return based on actual returns observed in markets during 

the years for which she computed effective tax rates.56 Other researchers have fixed a 

market interest rate (real or nominal), although not a separate rate for corporate 

equity.57 Those researchers typically calculated their effective tax rates a second time, 

specifying fixed before- or after-tax returns rather than fixed interest rates. (Studies 

that calculated effective tax rates a second time showed that the main qualitative conclusions were unchanged despite changes in effective tax rates for particular assets, 

sectors, or types of financing.)

CBO and Gravelle diverge from several other researchers in the use of actual rates of 

return faced by businesses. Actual returns include premiums to compensate savers for 

the inherent risks in business investments. Other researchers contend that effective tax

55. CBO’s decision to fix interest rates and the return on corporate equity for all alternative tax policies 

means that changes in individual income taxes included in those policies do not affect computations of the before-tax returns on investment financed by debt in any sector or by equity in the corporate sector. As can be seen in the equations determining before-tax returns (equations (23)–(25)), 

individual taxes have no effect except through the rates of return or other variables in the equation. 

In reality, changes in individual income taxes would affect before-tax returns to the extent that tax 

changes caused economic changes that in turn caused changes in interest rates, returns on corporate 

equity, or other parameters.

56. Gravelle, The Economic Effects of Taxing Capital Income, pp. 19–21 and 293; Gravelle, Capital 

Income Tax Revisions and Effective Tax Rates, p. 17.

57. King and Fullerton (The Taxation of Capital Income, pp. 11–12) computed effective tax rates 

assuming a fixed real before-tax rate of return as well as a fixed real market interest rate. Fullerton 

and Henderson (“Incentive Effects of Taxes,” pp. 86–88) assumed a fixed real after-tax return as 

well as a fixed market interest rate, as did Fullerton, Gillette, and Mackie (“Investment Incentives,” 

pp. 132–134). In contrast, Mackie (“Unfinished Business,” p. 307) picked one rate of return—that 

received by savers after taxes. When analysts specify before- or after-tax rates of return, they must 

rearrange their versions of the equations in the first section to solve for interest rates and returns on 

corporate equity.
76

rates cannot adequately portray how taxes affect risky returns.58 Those researchers 

specified rates of return derived from relatively risk-free assets such as government 

bonds. CBO chose returns that incorporate risk premiums with the assumption that 

doing so would produce tax rates closer to the rates businesses pay.

To test the sensitivity of CBO’s effective tax rates to assumptions about the rate of 

return, CBO substituted the rate of return on 10-year Treasury bonds for debt and 

equity returns of corporate investments. Treasury bonds are less risky than are corporate bonds, which, in turn, are less risky than corporate equities. The substitution 

caused little change in the effective tax rates, except that it led to larger differences in 

tax rates between investments financed by equity and those financed by debt. 

58. See, for example, Mackie, “Unfinished Business,” pp. 299–300.
77

Appendix: User’s Guide to the 

Effective Tax Rates Workbook

The Excel workbook, “effective tax rates.xls,” which accompanies this background 

paper, is posted at www.cbo.gov along with this background paper and a revised Excel 

workbook, “corrected ETRs.xls.”1 This user’s guide is intended for those who might 

wish to recalculate the effective tax rates using different parameters or update the 

capital stock data to a more recent year. The names of the worksheets are shown in 

boldface type, and special instructions are included in notes above the descriptions. 

The layouts were designed to be viewed on a 17-inch monitor with resolution set to 

1,024 768 pixels. Most sheets span several pages. Results are on the sheets to the left 

in the workbook, data and parameters appear in the middle sheets, and intermediate 

calculations are shown on the sheets to the right. Green-shaded cells are unprotected 

and can be changed to reflect alternative data sources, assumptions, and policies. Values in yellow-shaded cells carry over to other sheets.

The sheets of the workbook serve as a table of contents:

B Table 1

B Some detail

B Full detail

B IQ range (Interquartile range)

B Parameters

B NonresCapStk (Nonresidential capital stock)

B OthCapStk (Other capital stock)

B TxDeprFrml (Tax depreciation formulas)

B TxDeprMthd (Tax depreciation methods)

B EconDepr (Economic depreciation)

1. The revised version corrects minor errors described in footnotes 22, 36, and 49 of the main text of 

this background paper.
78

B Rates of return

B Inventories

B TxDeprPV_Ctot (Tax depreciation present value, corporate, total)

B TxDeprPV_Cdt (Tax depreciation present value, corporate, debt financed)

B TxDeprPV_Ceq (Tax depreciation present value, corporate, equity financed)

B TxDeprPV_Ntot (Tax depreciation present value, noncorporate, total)

Table 1

Note: This sheet has been protected and cannot be modified.

This sheet presents effective total tax rates and measures of tax rate uniformity as 

shown in Table 1 of the Congressional Budget Office (CBO) paper Taxing Capital 

Income: Effective Rates and Approaches to Reform (October 2005). The effective tax 

rates come from the worksheet Full detail, the interquartile range comes from the 

worksheet IQ range, and the other measures of tax rate uniformity are calculated 

internally. The interquartile range is the only measure that is not updated automatically when inputs are changed in other sheets. See IQ range for instructions on 

updating the interquartile range.

Some detail

Note: This sheet has been protected and cannot be modified.

This sheet presents effective total tax rates, the percentage distributions of assets 

(for Table A-1 of Taxing Capital Income) and certain intermediate calculations for 

eight aggregated equipment types (lines 4–11), four aggregated structure types (lines 

13–16), inventories (line 17), land (line 18), and total investment (line 19). It is laid 

out in two vertical pages as follows:

B Top page (rows 3–19): dollar distribution of assets [B] (columns B–E), cost of 

capital [ρ] (columns G–L), after-tax rates of return to savers [s] (column N)

B Bottom page (rows 24–40): percentage distribution of assets (columns B–E), 

effective total tax rates [ETTR] (columns G–L)

The values of B are aggregations of the constituent asset types from Full detail. The 

values of ρ are weighted averages of those associated with the constituent asset types 

from Full detail. Values of s come from Rates of return. The percentage distribution 

of assets and the ETTRs are calculated internally.
79

The aggregated asset types on Some detail are composed of asset types from Full 

detail. The asset types in each aggregation are separated in Full detail by gray 

dividing lines.

Full detail

Note: This sheet has been protected and cannot be modified.

This sheet presents effective tax rates and intermediate calculations by asset type and 

for specific aggregates (all equipment, all structures, all land, all business investment, 

all investment) on two vertical pages and three horizontal pages, as follows:

B Top vertical page (rows 3–35): equipment

B Bottom vertical page (rows 36–62): structures, inventories, land, totals

B Left horizontal page (columns B–M): asset distribution, tax splits, depreciation 

B Middle horizontal page (columns O–AB): cost of capital, tax wedges

B Right horizontal page (columns AC–AM): effective tax rates, effective total tax 

rates

Variable names referenced in formulas in the worksheet appear in Roman type without parentheses (for example, q(c) becomes qc). Some of the same variable names 

appear in the formulas in the methodology section of this background paper, where 

they are presented in italic type and with true subscripts instead of parenthetical subscripts. There, for example, the variable is shown as qc. In the workbook, the variables 

that are not defined on Full detail are defined either on the Parameters worksheet or 

on the Rates of return worksheet.

The contents of Full detail are summarized in Table A-1.

IQ range

Note: If you modify any other sheet, you must modify this one as well.

The purpose of this sheet is to feed into the interquartile range of ETTR(c) across 

asset types to the Table 1 worksheet. You should not modify any cell in this sheet 

directly, but you may need to update the sheet if you change a parameter on another 

sheet. To update this sheet, select the range “A5:C56.” Click on “Data/Sort.” On the 

Sort popup, choose “column C” and “descending” as the first sort criteria; ignore the 

other two sort criteria. When you click “OK,” the sort will execute. The updated 

ETTR at the first quartile will appear in cell F59, the updated ETTR at the third 

quartile will appear in cell G59, and the updated interquartile range (the difference 

between the two) will appear in cell H59.
80

Table A-1.

Worksheet Summary: Full detail

Continued

Column

Label Column Head Content

 A Name of asset type

Asset Distribution

B Value of stock [B], 

$billions

Value of capital stock in 2002 in billions of dollars. Equipment 

and structures (lines 3–54) come from NonresCapStk; 

inventories and land (lines 55–59) come from OthCapStk.

C Percentage 

distribution of 

stock

Distribution of capital stock, calculated as a percentage of all 

investment. This column is primarily an exhibit, but it is used to 

derive many of the cells in row 40 by weighting the two forms 

of organization for tenant-occupied housing.

Tax Splits (q)

D Share subject to 

corporate tax 

[q(c)]

Percentage of investments made by businesses subject to the 

corporate income tax. Equipment and structures come from 

NonresCapStk; inventories and land come from OthCapStk.

E Share subject to 

individual tax 

[q(n)]

Percentage of business investments not subject to the 

corporate income tax. Calculated as 100 percent minus q(c), 

except for owner-occupied houses and the land under them, 

which are zero.

F Share subject to no 

tax [q(h)]

Percentage of homeowner investments not subject to tax. 

Zero, except for owner-occupied housing and land, which are 

100 percent in this category.

Economic Depreciation

G Economic 

depreciation 

rate [δ]

Depreciation rate from EconDepr; not applicable to 

inventories or land.

H PV (corptot) of 

econ dep

Present value of economic depreciation per dollar of corporate 

investment. Calculated per equation (40) as

δ/[δ + r(c) − π]. Column H is used only to create column I.

I Ratio: PV tax to PV 

econ 

Ratio of the present value of tax depreciation (column J) to the 

present value of economic depreciation (column H). Column I 

provides a direct comparison of tax and economic depreciation 

by asset type. If the value is greater than 1.0, taxpayers can 

claim depreciation allowances faster than the assets 

themselves depreciate. The calculation is done using corporate 

investment, but it would be the same for a noncorporate 

investment.
81

Table A-1.

Continued

Continued

Column

Label Column Head Content

Present Value of Tax Depreciation [z]

J Corporate: total 

[z(c)]

Present value of tax depreciation per dollar of corporate 

investment financed using a typical mix of debt and equity, 

from TaxDeprPV_Ctot.

K Corporate: debtfinanced [z(c,d)]Present value of tax depreciation per dollar of debt-financed 

corporate investment, from TaxDeprPV_Cdt.

L Corporate: equityfinanced [z(c,e)]Present value of tax depreciation per dollar of equity-financed 

corporate investment, from TaxDeprPV_Ceq.

M Noncorporate 

[z(n)]

Present value of tax depreciation per dollar of noncorporate 

investment financed using a typical mix of debt and equity, 

from TaxDeprPV_Ntot.

Cost of Capital [ρ]

O Corporate: total 

[ρ(c)]

Real before-tax rate of return on all corporate investment, 

calculated per equation (23) as

{[r(c) − π + δ] × [1 − uz(c)]/(1 − u)} − δ.

P Corporate: debtfinanced [ρ(c,d)]

Real before-tax rate of return on debt-financed corporate 

investment, calculated per equation (23) (when f(c) = 1) as 

{[r(c,d) − π + δ] × [1 − uz(c,d)]/(1 − u)} − δ.

Q Corporate: equityfinanced [ρ(c,e)]

Real before-tax rate of return on equity-financed corporate 

investment, calculated per equation (23) (when f(c) = 0) as 

{[r(c,e) − π + δ] × [1 − uz(c,e)]/(1 − u)} − δ.

R Noncorporate 

[ρ(n)]

Real before-tax rate of return on noncorporate investment, 

calculated per equation (24) as 

[r(n) − π + δ] × [1 − t(n)z(n)]/[1 − t(n)]}.

S Owner-occupied 

housing [ρ(h)]

Before-tax rate of return on investment in owner-occupied 

housing, calculated per equation (25) as

[r(h) − π] − w × λ(h) × t(h). This column is irrelevant for 

nonresidential asset types.

T Overall [ρ] Before-tax rate of return on all investment, calculated as a 

weighted average of columns O, R, and S, using columns D, E, 

and F as the weights.
82

Table A-1.

Continued

Continued

Column

Label Column Head Content

Tax Wedges for Investors [ρ − r]

U Corporate: total The tax wedge is the difference between the before-tax rate of 

return and the after-tax rate of return. Column U is the tax 

wedge for corporate investment with a typical mix of debt- and 

equity-financing, calculated as ρ(c) − [r(c)′ − π].

V Corporate: debtfinancedTax wedge for debt-financed corporate investment, calculated 

as ρ(c,d) − [r(c,d)′− π].

W Corporate: equityfinancedTax wedge for equity-financed corporate investment, 

calculated as ρ(c,e) − [r(c,e)′− π].

Tax Wedges for Savers [ρ − s]

X Corporate: total Tax wedge for savers holding a typical mix of corporate stocks 

and bonds, calculated as ρ(c) − s(c).

Y Corporate: debtfinancedTax wedge for savers holding corporate bonds, calculated as 

ρ(c,d) − s(c,d).

Z Corporate: equityfinancedTax wedge for savers holding corporate stocks, calculated as 

ρ(c,e) − s(c,e).

AA Noncorporate Tax wedge for savers holding a typical mix of noncorporate 

equity and debt instruments, calculated as ρ(n) − s(n). Note 

that a noncorporate business owner is both an investor and a 

saver holding noncorporate equity. A saver holding noncorporate debt instruments, in contrast, is usually distinct 

from the investor.

AB Owner-occupied 

housing

Tax wedge for savers holding a typical mix of owner-occupied 

housing equity and debt instruments, calculated as 

ρ(h) − s(h). Note that a homeowner is both an investor and a 

saver holding housing equity. A saver holding housing debt 

instruments, in contrast, is distinct from the investor. Column 

AB is irrelevant for nonresidential asset types.

Effective Tax Rates [ETR] Calculations follow equation (1) after using equation (23) to 

substitute for “before” and equation (6) to substitute for 

“after.”

AC Corporate: total 

[ETR(c)]

Effective tax rate imposed on corporate businesses on net 

corporate income from a typical mix of debt- and equityfinanced investments is calculated as 

{ρ(c) − [r(c)′ − π]}/ρ(c).
83

Table A-1.

Continued

Source: Congressional Budget Office.

Column

Label Column Head Content

Effective Tax Rates [ETR] (continued)

AD Corporate: debtfinanced 

[ETR(c,d)]

Effective tax rate imposed on corporate businesses on net 

corporate income from debt-financed investments is 

calculated as {ρ(c,d) − [r(c,d)′ − π]}/ρ(c,d).

AE Corporate: equityfinanced 

[ETR(c,e)]

Effective tax rate imposed on corporate businesses on net 

corporate income from equity-financed investments is 

calculated as {ρ(c,e) − [r(c,e)′ − π]}/ρ(c,e).

Effective Total Tax Rates [ETTR]

AF Corporate: total 

[ETTR(c)]

Effective tax rate on income from a typical mix of corporate 

stocks and bonds, calculated per equation (12) as

[ρ(c) − s(c)]/ρ(c).

AG Corporate: debtfinanced 

[ETTR(c,d)]

Effective tax rate on income from corporate bonds, calculated 

per equation (12) (when f(c) = 1) as [ρ(c,d) − s(c,d)]/ρ(c,d).

AH Corporate: equityfinanced 

[ETTR(c,e)]

Effective tax rate on income from corporate stocks, calculated 

per equation (12) (when f(c) = 0) as [ρ(c,e) − s(c,e)]/ρ(c,e).

AI Noncorporate 

[ETTR(n)]

Effective tax rate on income from a typical mix of noncorporate 

equity and debt instruments, calculated per equation (17) as

[ρ(n) − s(n)]/ρ(n).

AJ Owner-occupied 

housing [ETTR(h)]

Effective tax rate on income from a typical mix of owneroccupied housing equity and debt instruments, calculated per 

equation (22) as [ρ(h) − s(h)]/ρ(h).

AK Overall [ETTR] Effective tax rate on income from a typical mix of all equity and 

debt instruments, calculated as (ρ − s)/ρ.

AM Average rate of 

return to savers 

[s]

The after-tax rate of return on all assets, calculated as a 

weighted average of s(c), s(n), and s(h), using columns D, E, 

and F as the weights.
84

Parameters

This sheet is the repository of most parameters that do not vary by asset type. It also 

contains information on where to enter parameters that do vary by asset type. The 

sheet is laid out in four vertical pages as follows:

B Top page (rows 3–28): marginal investments, depreciation, sources of financing, 

market rates of return

B Second page (rows 29–57): sources of marginal saving

B Third page (rows 58–86): tax parameters

B Bottom page (rows 87–89): inventory parameters

Except where noted, the implementation section of this background paper describes 

how the CBO selected the values it used for the parameters.

Variable names referenced in formulas in the sheet appear without the parentheses 

(for example, “t(div)” becomes “tdiv”). For legibility in the formulas, Greek characters 

with subscripts are shown as their capital Roman counterparts (specifically, “α” is “A” 

and “λ” is “L”). Greek characters without subscripts are simply spelled out (specifically, “π” is “pi,” “γ” is “gamma,” and “φ” is “phi”). Some of the same variable names 

appear in formulas in the methodology section, where they are shown with true subscripts instead of parenthetical subscripts.

Marginal investments

These parameters vary by asset type and are not entered on this sheet. The amounts 

of marginal investment by type of asset, B, are entered on the NonresCapStk and 

OthCapStk worksheets and appear in column B of the Full detail worksheet. The 

tax shares—q(c), q(n), and q(h)—are also entered on the NonresCapStk and 

OthCapStk worksheets and appear in columns D–F of Full detail.

Depreciation

These parameters, which vary by asset type and in some cases by industry, also are not 

entered on this sheet. The tax depreciation parameters are entered on two sheets. The 

depreciation formulas themselves are entered on TaxDeprFrml. Those formulas are 

assigned to asset types and industries on the TaxDeprMthd worksheet. The present 

values of depreciation deductions per dollar invested, z, are displayed on the four 

TaxDeprPV worksheets, and the weighted-average values of z by asset type are displayed in columns J–M of Full detail. Economic depreciation rates, δ, are entered on 

the EconDepr worksheet and displayed in column G of Full detail.

Sources of financing

Cells A16–A18 show the percentage of marginal investment financed by debt—

labeled f(c), f(n), and f(h) for corporate, noncorporate, and owner-occupied housing 
85

investment, respectively. The values are used in the Rates of return worksheet to calculate weighted-average values of the after-tax rates of return to savers, s(c), s(n), and 

s(h). They also are used there to compute the discount rates of businesses, r(c) − π and 

r(n) − π; and homeowners, r(h) − π.

Cell A19 is for m, the share of after-tax profits retained by C corporations. The value 

depends on whether one accepts the new view or the old view of the tax on corporate 

dividends. The value is used in the Rates of Return worksheet to calculate the aftertax rate of return on corporate equity in fully taxable accounts, s(c,e,ft).

Market rates of return

Cell A22 shows π, the rate of inflation, a value used extensively throughout the workbook, particularly to convert a real (inflation-adjusted) rate of return to a nominal rate 

and to calculate the present value of depreciation deductions.

Cell A23 is the real pretax rate of return on corporate equity, E. The value is used 

extensively throughout the workbook, particularly for calculating average rates of 

return on investment financed with a typical mix of debt and equity, and for calculating the pretax rate of return on equity-financed corporate investment by asset type.

Cell A24 shows the nominal interest rate, i. The value is used extensively in the Rates 

of return worksheet to calculate average rates of return on investment financed with 

debt and with a typical mix of debt and equity.

Sources of marginal saving

The calculation of ETTRs considers three sources of marginal saving: fully taxable 

accounts, temporarily deferred accounts (such as whole-life insurance and nonqualified annuities), and nontaxable accounts (such as individual retirement accounts 

and employment-based pensions). The percentages representing each source, α, are 

entered in this section. Different splits are permitted by tax treatment (corporate, 

noncorporate, owner-occupied housing) and by source of financing (equity, debt). 

Equity-financed investment by noncorporate businesses (rows 39–41) and by homeowners (rows 47–49) is assumed to come entirely from taxable accounts. In the other 

four blocks, entries are made for fully taxable accounts and for temporarily deferred 

accounts, leaving the percentage coming from nontaxable accounts as the residual. 

The values are used in the Rates of return worksheet to calculate after-tax rates of 

return to savers using a typical mix of taxable, temporarily deferred, and nontaxable 

accounts. The entries and their uses are summarized in Table A-2.
86

Table A-2.

Parameters Summary, Sources of Marginal Saving

Source: Congressional Budget Office.

a. For improved legibility, α is shown as A in the spreadsheet’s formulas.

Tax Parameters

Cell A59 is the corporate tax rate, u. The value is used in Rates of return to calculate 

the after-tax rate of return to corporate investors using debt financing, r(c,d) − π and 

r(c) − π, and in the Full detail (columns O, P, and Q) and Inventories (rows 9–14) 

worksheets to calculate the before-tax rate of return on corporate capital, ρ(c).

The individual income tax rates on specific types of income or expenses are contained 

in cells A61–A70:

Cell A61 gives the tax rate on dividend income, t(div). The value is used in Rates of 

return to calculate the after-tax rate of return to savers holding corporate equity in 

fully taxable accounts, s(c,e,ft).

Cell A62 shows the tax rate on capital gains not realized prior to death, t(xcg). The 

value (zero, under current law) is strictly an exhibit.

Cells A63 and A64 show the tax rates on realized long-term capital gains, t(lcg); the 

first on real gains and the second on inflationary gains. The values are typically the 

same, but providing two parameters facilitates the simulation of the partial integration 

proposal and the indexing of capital gains for inflation in the President’s 2003 budget. 

The values are used in Rates of return, where they ultimately feed into the after-tax 

rate of return to savers holding corporate equity in fully taxable accounts, s(c,e,ft).

Marginal-Saving Source Namea

Cell in Parameters

Worksheet

Corporate Equity-Financed Investment

Taxable accounts α(c,e,ft) A31

Temporarily deferred accounts α(c,e,td) A32

Corporate Debt-Financed Investment 

Taxable accounts α(c,d,fd) A35

Temporarily deferred accounts α(c,d,td) A36

Noncorporate Debt-Financed Investment

Taxable accounts α(n,d,ft) A39

Temporarily deferred accounts α(n,d,td) A40

Owner-Occupied Housing Debt-Financed Investment 

Taxable accounts α(h,d,ft) A43

Temporarily deferred accounts α(h,d,td) A44
87

Cells A65 and A66 are for the tax rates on realized short-term capital gains, t(scg); 

the first on real gains and the second on inflationary gains. The values are used in 

Rates of return, where they ultimately feed into the after-tax rate of return to savers 

holding corporate equity in fully taxable accounts, s(c,e,ft).

Cell A67 shows the tax rate on interest income, t(int). The value is used in Rates of 

return to calculate the after-tax rate of return to savers holding corporate debt in fully 

taxable accounts, s(c,d,ft).

Cell A68 shows the tax rate on mortgage interest deductions, t(h). The value is used 

in Rates of return to calculate the after-tax rate of return to homeowners using a 

typical mix of debt and equity financing, r(h) − π, and in Full detail (column S) to 

calculate the before-tax rate of return on owner-occupied-housing capital, ρ(h).

Cell A69 shows the tax rate on noncorporate business income, t(n). The value is used 

in Rates of return to calculate the after-tax rate of return to noncorporate business 

investors, r(n) − π, and in Full detail (column R) and Inventories (rows 19 and 20) to 

calculate the before-tax rate of return on noncorporate business capital, ρ(n).

Cell A70 is the tax rate on nonqualified annuities, t(td). The value is used in Rates of 

return to calculate the after-tax rate of return to savers holding corporate equity and 

debt—s(c,e,td) and s(c,d,td), respectively—in temporarily deferred accounts.

Cell A71 is the average property tax rate, w. The value is used in Full detail (column 

S) to calculate the before-tax rate of return on owner-occupied-housing capital, ρ(h).

Cell A73 is the deductible share of mortgage interest and property taxes, λ(h). The 

value is used in the Rates of return worksheet to calculate the after-tax rate of return 

to homeowners, r(h) − π, and in Full detail (column S) to calculate the before-tax 

rate of return on owner-occupied-housing capital, ρ(h).

Cell A74 shows the deductible share of business interest, λ(c) and λ(n). Under current law, this parameter has a value of 1.0, but it would be zero under a pure consumption tax or a wage tax. It is used in Rates of return to calculate the after-tax rate 

of return to business investors using debt financing, r(c) − π and r(n) − π, and in 

Inventories to calculate the cost of debt-financed capital.

The deferral of tax on capital gains complicates the calculation of s(c,e,ft), the aftertax rate of return to savers who hold corporate equity in fully taxable accounts. The 

parameters required to complete that calculation are entered in cells in the range 

A76–A83. The capital gains portion, g, of the calculation of s(c,e,ft) is performed on 

the top page of Rates of return. The parameters are as follows:
88

Cell A77 is the percentage of realized capital gains that are short term (that is, the 

assets sold were held for less than one year). The long-term percentage is calculated as 

a residual and displayed in cell A76.

Cell A79 shows the percentage of capital gains that are not realized before a shareholder dies. The realized capital gains are apportioned between long- and short-term 

gains in cells A76 and A77, respectively.

Cells A82 and A83 contain the average holding period for long-term, Y(lcg), and 

short-term, Y(scg), capital gains, respectively.

The deferral of tax on investment earnings in whole-life insurance and nonqualified 

annuities complicates the calculation (in the Rates of return worksheet) of the aftertax rate of return to savers holding debt in those temporarily deferred accounts, 

s(c,d,td). The parameters required to complete that calculation are entered in cells 

A80 and A84.

Cell A80 shows the percentage of payments made from temporarily deferred accounts 

that are nontaxable death benefits, γ.

Cell A84 shows the average holding period of assets in temporarily deferred accounts, 

Y(td).

Inventories

This section contains two parameters that feed into the Inventories worksheet.

Cell A88 is for the average holding period of inventories, Y(v).

Cell A89 contains the percentage of inventories accounted for with the “first-in, 

first-out” method, φ.

NonresCapStk

Note: You can modify only the green-shaded cells in this sheet.

This worksheet has two functions: to specify a distribution of nonresidential investment in equipment and structures by industry and asset type, and to convert tax splits 

by industry into tax splits by asset type.

Industries are arrayed vertically over two pages and asset types are arrayed horizontally 

over seven pages. Industries are repeated three times as follows:

B First block (rows 2–67): all investment

B Second block (rows 68–133): corporate investment (in blue)
89

B Third block (rows 134–199): noncorporate investment (in green)

Distribution of Investment by Industry and Asset Type

To represent the base case and all policy alternatives, CBO assumed that marginal 

nonresidential investment by industry and asset type was proportional to the current 

value of nonresidential assets in 2002. You might want to modify that distribution 

(contained in the range E5–AY67) if you believe either that investment is distributed 

differently than current assets or that it would be more appropriate to use data for a 

different year. 

The source of the current value of nonresidential assets was the spreadsheet called 

“detailnonres_stk1.xls,” which is available from the Department of Commerce Bureau 

of Economic Analysis (BEA): www.bea.gov/bea/dn/FA2004/Details/Index.html. 

(Note that the 2002 data in this spreadsheet have been updated since CBO originally 

downloaded them.) That spreadsheet carries the following disclaimer:

The Bureau of Economic Analysis (BEA) does not include detailed estimates by 

industry and by type in the tables published in the Survey of Current Business or 

the Fixed Assets and Consumer Durables volume because their quality is significantly less than that of the higher level aggregates in which they are included. 

Compared to these aggregates, the detailed estimates are more likely to be either 

based on judgmental trends, on trends in the higher level aggregate, or on less 

reliable source data.

CBO retained all asset types in the BEA spreadsheet. For the most part, the industries 

in the BEA spreadsheet also were retained. Some limited aggregation of the industries 

was necessary, however, because the same level of detail was not available for the tax 

split parameters (see Box 2 on page 31).

The BEA figures include the assets of nonprofit organizations. Because they are nontaxable entities, there is no tax burden on their investment, so it is unnecessary to calculate an effective tax rate. If those assets were retained in the data, they would serve 

to overweight the effective tax rates on asset types that are most commonly owned by 

nonprofits. Therefore, those assets were removed from the data as described in the 

methodology section of this background paper.

Total investment by asset type is summed over all industries and displayed in row 3. 

After dividing by 1,000, those amounts are fed into column B of Full detail.

Converting Tax Splits by Industry to Tax Splits by Asset Type

The share of assets in each industry that is held by businesses subject to the corporate 

income tax is contained in the range D71–D133 of the worksheet NonresCapStk. 

The method by which these values were estimated was described in the main text, but 

the values could be modified to reflect more recent information or to correct for any 

distortion inherent in using tax data to perform the estimates. The share of assets in 
90

each industry held by businesses that are not subject to the corporate income tax is 

calculated as the difference between 100 percent and the corporate share, and it is displayed in cells D137–D199 (which cannot be modified directly).

The corporate share in each industry is multiplied by the corresponding industry’s 

investment in each asset type to yield an estimate, by industry and by asset type, of 

investment subject to the corporate income tax. The results, which cannot be modified directly, are contained in the range E71–AY133. Total corporate investment in 

each asset type (row 69) is divided by total business investment in that asset type 

(row 3) to derive an estimate of the corporate share by asset type (row 68), which is 

fed to column D of the Full detail worksheet.

Noncorporate investment is the difference between total investment and corporate 

investment. Those amounts are calculated and displayed in the range E137–AY199 

(which cannot be modified directly). Total noncorporate investment by asset type 

appears on line 135, and the noncorporate share by asset type (which corresponds to 

column E of Full detail) appears in row 134.

OthCapStk

Note: You can modify only the green-shaded cells in this sheet.

This worksheet specifies distributions of investment in residential equipment and 

structures, inventories, and land among the three tax treatments. The values feed into 

cells in columns B and D of rows 14, 37–40, 55, and 57–59 in the Full Detail worksheet. OthCapStk is displayed on a single page in two parts: Rows 1–6 cover residential equipment and structures; rows 15–20 cover inventories and land.

Residential Equipment and Structures

To be consistent with nonresidential investment, CBO assumed that marginal residential investment was proportional to the current value of residential assets in 2002. 

You can modify those figures (contained in cells E3, G3, I3, and K3) if you believe 

either that investment is distributed differently than current assets or that data for a 

different year would be more appropriate. The value of residential assets was aggregated from BEA data as described in the implementation section of this background 

paper. That section also describes how the values were distributed among tax treatments. The resulting values and corporate shares are placed in OthCapStk as shown 

in Table A-3.

Corresponding figures for noncorporate shares (100 percent, less the corporate share) 

can be found in row 5 of the corresponding columns (D, H, and J). By definition, the 

owner-occupied housing share is zero, as shown in row 6 of the corresponding columns. Under federal law, income from owner-occupied houses is not subject to the 

corporate or individual income tax, so the owner-occupied-housing share is 100 percent. The tax shares were set accordingly in the range F4–F6.
91

Table A-3.

Residential Capital Stock: Amounts and Tax Treatment

Source: Congressional Budget Office.

Note: n.a. = not applicable.

Inventories and Land

Sources of data for inventories and land also are described in the implementation section. The amounts for inventories were entered into cell E17, and the data on land 

were available for owner-occupied housing (cell G17) and for tenant-occupied housing owned by a corporation (cell I17) or noncorporate businesses (cell K17). Those 

data should not be confused with the tax treatment shares below.

Tax shares were calculated as described in the implementation section. The values for 

inventories, corporate land, and noncorporate land were entered in cells D18, H18, 

and J18, respectively. All land attached to owner-occupied housing was assigned to 

homeowners. The tax shares were set accordingly in the range F18–F20.

TxDeprFrml

Note: You can modify only the green-shaded cells in this sheet.

In this worksheet, the formulas from the methodology section that are used to compute the present value of tax depreciation allowances are applied to the main parameters allowed by federal tax laws in place from 2000 through 2006. The computations 

are grouped by the two generic methods of depreciation: declining balance and 

straight line. Within each generic method, present values are computed for each combination of the main parameter values allowed under the tax law. All combinations of 

parameters can accommodate partial expensing and the trivial extension to full 

expensing. Parameters that define the annual percentage recovery method proposed 

by the President’s Advisory Panel on Federal Tax Reform also are included.

As identified in the methodology section of this background paper, present values 

depend on discount rates of the firms making the investments and on the tax depreciation formulas allowed by tax law. The discount rates used in the calculations on this 

sheet are for the following tax treatments and sources of financing:

B Corporations using a typical mix of debt and equity, r(c),

Cell Contents

Asset type Value Corporate Share

Equipment E3 D4

Owner-Occupied Structures G3 n.a.

Corporate-Owned Tenant-Occupied Structures I3 H4

Noncorporate-Owned Tenant-Occupied Structures K3 J4
92

B Corporations using debt financing, r(c,d),

B Corporations using equity financing, r(c,e), and

B Noncorporate businesses using a typical mix of debt and equity financing, r(n).

This worksheet is laid out in two vertical pages as follows:

B Top page: declining-balance method with a switch to straight-line depreciation 

(rows 2–30)

B Bottom page: straight-line method (rows 32–40), annual recovery percentage 

method (rows 42–50)

Each generic method is associated with a series of predetermined parameter values 

that are combined to generate names representing specific methods you can assign to 

asset types and industries on the worksheet TxDeprMthd.

For example, the five-year straight-line method is “sl_5.” The parameters that define 

the specific methods are not protected, so they can be changed. The names, however, 

cannot be changed. Thus, it is permissible to replace five-year straight-line depreciation with six-year straight-line depreciation, but the name will remain “sl_5.”

Declining-Balance Method with Switch to Straight-Line Method

The declining-balance method accelerates depreciation into the early years of an 

asset’s life. Under current law, when the depreciation deductions under the decliningbalance method fall below those under the straight-line method, the taxpayer switches 

to straight-line depreciation. That switch is reflected in the present values calculated 

in this section of TxDeprFrml.

The declining-balance method is defined by the discount rate and two parameters: the 

tax life, Y, and the rate of acceleration, b. The tax life is the period over which an asset 

can be completely depreciated. The acceleration rate determines the timing of the 

depreciation deductions; the higher the acceleration rate, the higher the percentage 

that can be deducted in the early years. Ten combinations of Y and b used under current law are entered in columns E–N. Values of Y are shown on row 4, and values of b

are shown on row 5. The names are shown in row 3, with the naming convention 

dbb_Y, where “db” stands for declining balance. Row 6 contains a parameter, x, to 

permit partial or full expensing.

Rows 8 and 9 contain intermediate calculations of the geometric rate of decay, β, and 

Y*, the time at which the declining-balance method gives way to the straight-line 

method. The present values of depreciation deductions under this method are presented in four blocks of five lines each (rows 11–30). The four blocks represent the 

different tax treatments and sources of financing listed above.
93

Table A-4.

TxDeprMthd Worksheet Locations of Values Associated with 

Declining-Balance Depreciation

Source: Congressional Budget Office.

Within each block, the first four rows represent intermediate calculations (which are 

useful for deconstructing the formula); the last row represents the corresponding 

present value for a particular tax treatment and source of financing as specified in 

equation (34) in the methodology section. These are the cells that are named so they 

can be referenced in the worksheet TxDeprMthd. The names are constructed by 

combining a prefix that represents the tax treatment or source of financing from column B with the specific method name from row 3. The cells are named as shown in 

Table A-4.

Straight-Line Method

As shown by equation (28) in the methodology section, the straight-line method is 

defined by the discount rate and a single parameter—the tax life, Y. Depreciation 

deductions equal to an asset’s acquisition cost are spaced out evenly over that period. 

The eight different values of Y used under current law are entered in the range 

E34–L34. The names are shown in row 33 by the following naming convention: sl_Y, 

where “sl” stands for straight line. Row 35 contains a parameter, x, to permit partial or 

full expensing. 

The present values of depreciation deductions under the straight-line method are presented on rows 37–40, each representing one of the combinations of tax treatment 

and source of financing listed above. Each cell is named so it can be referenced in the 

TxDeprMthd worksheet. The names are constructed by combining a prefix that represents the tax treatment or source of financing from column B with the specific 

method name from row 33. The cells are named as shown in Table A-5.

Cell Name Cell Name Cell Name Cell Name

E15 db2_3 E20 Ddb2_3 E25 Edb2_3 E30 Ndb2_3

F15 db2_5 F20 Ddb2_5 F25 Edb2_5 F30 Ndb2_5

G15 db2_7 G20 Ddb2_7 G25 Edb2_7 G30 Ndb2_7

H15 db2_10 H20 Ddb2_10 H25 Edb2_10 H30 Ndb2_10

I15 db1.5_3 I20 Ddb1.5_3 I25 Edb1.5_3 I30 Ndb1.5_3

J15 db1.5_5 J20 Ddb1.5_5 J25 Edb1.5_5 J30 Ndb1.5_5

K15 db1.5_7 K20 Ddb1.5_7 K25 Edb1.5_7 K30 Ndb1.5_7

L15 db1.5_10 L20 Ddb1.5_10 L25 Edb1.5_10 L30 Ndb1.5_10

M15 db1.5_15 M20 Ddb1.5_15 M25 Edb1.5_15 M30 Ndb1.5_15

N15 db1.5_20 N20 Ddb1.5_20 N25 Edb1.5_20 N30 Ndb1.5_20
94

Table A-5.

TxDeprMethd Worksheet Locations of Values Associated 

with Straight-Line Depreciation

Source: Congressional Budget Office.

Annual Recovery Percentage Method

Under the annual recovery method, a fixed percentage of the undepreciated value of 

an asset is deducted each year. As shown in equation (36) in the methodology section, 

the method is defined by the discount rate and a single parameter—the annual recovery percentage, β—which is conceptually identical to the geometric rate of decay used 

above. Eight values of β are entered in the range E44–L44. The names are shown in 

row 43 using the following naming convention: arp_β, where “arp” means annual 

recovery percentage. Row 45 contains a parameter, x, which permits partial or full 

expensing. 

The present values of depreciation deductions under this method are presented on 

four rows (47–50), each representing one combination of tax treatment and source of 

financing, as listed above. Each cell is named so it can be referenced in the worksheet 

TxDeprMthd. The names are constructed by combining a prefix that represents the 

tax treatment or source of financing from column B with the specific method name 

from row 43. The cells are named as shown in Table A-6.

TxDeprMthd

Note: The cells in this sheet are not protected. Cells shaded in blue rather than in green, 

however, should be modified only in exceptional circumstances.

This sheet identifies the specific tax depreciation method to apply to each asset type in 

each industry. Asset types are arrayed horizontally over five pages, and industries are 

arrayed vertically over two pages. Hybrid methods can be created on a third vertical 

page for cases in which tax definitions of asset types or industries do not correspond 

closely to those used by BEA in generating its data on current asset values.

Cell Name Cell Name Cell Name Cell Name

E37 sl_3 E38 Dsl_3 E39 Esl_3 E40 Nsl_3

F37 sl_5 F38 Dsl_5 F39 Esl_5 F40 Nsl_5

G37 sl_7 G38 Dsl_7 G39 Esl_7 G40 Nsl_7

H37 sl_10 H38 Dsl_10 H39 Esl_10 H40 Nsl_10

I37 sl_15 I38 Dsl_15 I39 Esl_15 I40 Nsl_15

J37 sl_20 J38 Dsl_2 J39 Esl_20 J40 Nsl_20

K37 sl_27.5 K38 Dsl_27.5 K39 Esl_27.5 K40 Nsl_27.5

L37 sl_39 L38 Dsl_39 L39 Esl_39 L40 Nsl_39
95

Table A-6.

TxDeprMthd Worksheet Locations of Values Associated with 

Annual Recovery Percentage Depreciation

Source: Congressional Budget Office.

Depreciation methods are identified by entering the name of the specific depreciation 

method defined in TxDeprFrml into each cell. The names shown on rows 3, 33, and 

43 of that sheet are valid here—the prefixes shown in column B should not be 

included in the names.

It is not necessary to type the desired name into each cell. For every asset type, row 67 

(shaded green at the bottom of the middle vertical page) contains the name of a 

default depreciation method that automatically appears in every row for that asset 

type, unless it is manually overridden. Such overrides are necessary when assets in a 

particular industry are treated differently from those in other industries. The overrides 

used for current law are shown with darker blue shading. 

Cells filled with default values under current law are shaded lighter blue, but they are 

not protected and can be overridden if necessary. The name in each cell of the 

TxDeprMthd worksheet is used to identify the cell in the worksheet TxDeprFrml

from which the present value of depreciation deductions should be fed into the corresponding cells in TxDeprPV. For example, if cell C3 contains a value of “sl_3,” then 

cell C3 in TxDeprPV_Ctot will, under current law, be fed a value of 0.9005, because 

that is the content of the cell named “sl_3” (E37) in TxDeprFrml.

In addition to the names defined on the TxDeprFrml worksheet, two other entries 

are valid:

B “Mixed” may be entered to create a hybrid method, which is defined using the 

parameters on the bottom page. Rows 70 and 72 identify two methods; rows 71 

and 73 are then used to weight those methods. Corresponding cells in the 

TxDeprPV worksheets will contain a weighted average of the two present values 

from TxDeprFrml. Only one hybrid method can be defined per asset type.

Cell Name Cell Name Cell Name Cell Name

E47 arp_30 E48 Darp_30 E49 Earp_30 E50 Narp_30

F47 arp_20 F48 Darp_20 F49 Earp_20 F50 Narp_20

G47 arp_15 G48 Darp_15 G49 Earp_15 G50 Narp_15

H47 arp_10 H48 Darp_10 H49 Earp_10 H50 Narp_10

I47 arp_7.5 I48 Darp_7.5 I49 Earp_7.5 I50 Narp_7.5

J47 arp_5 J48 Darp_5 J49 Earp_5 J50 Narp_5

K47 arp_4 K48 Darp_4 K49 Earp_4 K50 Narp_4

L47 arp_3 L48 Darp_3 L49 Earp_3 L50 Narp_3
96

B “Econ” may be entered to make tax depreciation equal to economic depreciation 

for the asset class from the EconDepr worksheet. For uniform economic depreciation, enter “Econ” into all green and dark blue cells.

The list of asset types across row A includes all of those from NonresCapStk plus 

three entries for the residential capital stock: equipment, corporate-owned structures, 

and noncorporate-owned structures. The distinction between corporate and noncorporate follows the definitions used by BEA and conforms to the “legal form of 

organization” concept, not the “tax treatment” concept. The depreciation method for 

the three residential asset types is entered on row 67; there is no industry breakdown.

EconDepr

This sheet specifies rates of economic depreciation, δ, by asset type. The sheet is laid 

out over two vertical pages:

B Top (rows 3–34): nonresidential equipment

B Bottom (rows 36–59): residential equipment, all structures

Economic depreciation rates are entered in column B. They feed into column G of 

Full detail, where they are used to calculate ρ, the before-tax rate of return on capital. 

They are also available to enter the calculation of present value of depreciation deductions in the TxDeprPV worksheets whenever a value of “econ” is entered into a cell of 

the TxDeprMthd sheet. (Because asset types are arrayed horizontally in the tax depreciation worksheets, values of δ are transposed in EconDepr in the range D2–BA2.)

Rates of return

Note: This sheet has been protected and cannot be modified.

This sheet is for calculation and display of the various after-tax rates of return used to 

calculate the effective tax rate (ETR) and effective total tax rate (ETTR). It is laid out 

in two vertical pages as follows:

B Top (rows 3–15): capital gains portion of the return on corporate equity

B Bottom (rows 20–46): after-tax rates of return to savers and investors

Variable names referenced in formulas in the sheet appear without parentheses or 

commas; for example, s(c,e) becomes sce. Greek variables with subscripts appear in 

formulas as their Roman capital counterparts (“α” is “A,” “λ” is “L,” “ω” is “W”). 

Greek variables without subscripts are spelled out (“π” is “pi”). Some of the same variable names appear in the formulas in the methodology section, where they are presented with true subscripts.
97

Capital Gains

The capital gains section of the Rates of return worksheet constructs the capital gains 

portion of the after-tax rate of return on corporate equity. Cells in the range A5–A11 

use the information in cells A77 and A79 from the Parameters worksheet to create 

weights for short-term capital gains, ω(scg); long-term capital gains, ω(lcg); and capital gains not realized prior to death, ω(xcg). 

Cell A13 computes the real after-tax rate of return for short-term gains, g(scg), using 

equation (46) from the methodology section (and, in the case of the President’s integration proposal, equation (50) from the methodology section). Cell A14 computes 

the analogous return for long-term gains, g(lcg), substituting equation (47) for equation (46). Cell A15 computes the untaxed rate of return on gains held until death, 

g(xcg). Each cell uses a variety of values from the “Market rates of return” and “Tax 

parameters” sections of the Parameters worksheet. Cell A16 applies the weights to the 

rates of return to produce a weighted average of the capital gain portion of the aftertax rate of return on corporate equity, g. That value is combined with the dividend 

portion below in cell A25.

Real After-Tax Rates of Return to Savers

This section calculates after-tax rates of return to savers by source of financing and 

type of account, then applies weights to generate more aggregated rates of return. The 

most basic calculations, which use a variety of values from the Parameters worksheet 

sections labeled “Market rates of return” and “Tax parameters,” are as follows:

Cell A26 shows the return on equity held in fully taxable accounts, s(c,e,ft), per 

equation (9) from the methodology section.

Cell A27 shows return on equity held in temporarily deferred accounts, s(c,e,td), per 

equation (53).

Cell A28 shows return on equity held in nontaxable accounts, s(c,e,nt).

Cell A30 shows return on debt held in fully taxable accounts, s(c,d,ft), per the first 

term on the right-hand side of equation (8) in the methodology section.

Cell A32 shows return on debt held in temporarily deferred accounts when not 

applied to death benefits, per equation (51).

Cell A33 shows return on debt held in temporarily deferred accounts when applied to 

death benefits, per equation (52).

Cell A34 shows return on debt held in nontaxable accounts, s(c,d,nt).

The remaining cells contain rates of return that reflect different levels of aggregation. 

Their values are calculated by applying weights either from the Parameters worksheet 
98

Table A-7.

Aggregated Rates of Return to Savers

Source: Congressional Budget Office.

Aggregation Cell Components Weights

Distribution Form (Death 

benefit, other)

Corporate debt in 

temporarily deferred 

accounts, s(c,d,td)

A31 A33, A32 γ , 1 − γ 

Account Type (Fully taxable, 

temporarily deferred, 

nontaxable)

Corporate equity, s(c,e), per 

equation (10)

A25 A26, A27, A28 α[c,e,ft], α[c,e,td], 

α[c,e,nt]

Corporate debt, s(c,d), per 

equation (8)

A29 A30, A31, A34 α[c,d,ft], α[c,d,td], 

α[c,d,nt]

Noncorporate equity, s(n,e) A36 A25 None

Noncorporate debt, s(n,d), 

per equation (15)

A37 A30, A31, A34 α[n,d,ft], α[n,d,td], 

α[n,d,nt]

Owner-occupied housing 

equity, s(h,e)

A39 A25 None

Owner-occupied housing 

debt, s(h,d), per equation 

(20)

A40 A30, A31, A34 α[n,d,ft], α[n,d,td], 

α[n,d,nt]

Financing Source (Equity, debt)

Corporate investment, s(c), 

per equation (11)

A24 A25, A29 1 − f[c], f[c]

Noncorporate investment, 

s(n), per equation (16)

A35 A36, A37 1 − f[n], f[n]

Owner-occupied housing 

investment, s(h), per 

equation (21)

A38 A39, A40 1 − f[h], f[h]

Tax Treatment (Corporate, 

noncorporate, owner-occupied 

housing)

Business investment A23 A24, A35 q[c], q[n]

Total investment A22 A24, A35, A39 q[c], q[n], q[h]
99

or from the Full detail worksheet, as appropriate. Table A-7 summarizes the construction of the aggregate measures.

After-Tax Rates of Return to Businesses and Homeowners

This section calculates discount rates and after-tax rates of return to businesses and 

homeowners by source of financing. It applies weights to generate aggregated discount 

rates and after-tax rates of return by tax treatment. The type of account in which 

assets are held is not important to investors. The calculations for corporate equity 

(cell A44) and debt (cell A45) use a variety of values from the “Market rates of return” 

and “Tax parameters” sections of the Parameters worksheet.

Cells A43, A46, and A47 contain rates of return that aggregate over different sources 

of financing using the same weights shown in Table A-7 for cells A24, A35, and A37.

Cells A43, A44, and A45 are based on equation (5) of the methodology section. Cell 

A46 is based on equation (14), and cell A47 is based on equation (19).

The corresponding after-tax rates of return, per equation (6) in the methodology 

section, are contained in column D.

Inventories

Note: This sheet has been protected and cannot be modified.

This sheet is for calculation and display of the rates of return and effective tax rates on 

inventories. The calculations for inventories differ from those for other types of assets, 

so isolating them is the least confusing option. The sheet is laid out in two vertical 

pages as follows:

B Top: nominal discount rates (rows 3–5), cost of capital (rows 7–21)

B Bottom: effective tax rates on investors (rows 26–36), effective tax rates on savers 

(rows 38–49)

Calculations for inventories, unlike those for other assets, must consider the accounting method used: LIFO (last-in, first-out) or FIFO (first-in, first-out). Before-tax rates 

of return, ρ, and effective tax rates, ETR and ETTR, are first calculated by source of 

financing for each accounting method using tax rates u and t(n); holding periods 

Y(v); and inflation rates, π; from the Parameters worksheet.

The before-tax rates of return are computed according to equations (55) and (57) in 

the methodology section of this background paper. Weighted averages of the two 

accounting methods are then calculated using φ from Parameters. Weighted averages 

of debt and equity financing also are calculated using f(c) from Parameters. The 

resulting values are fed into row 55 of Full detail.
100

TxDeprPV_

Note: These sheets have been protected and cannot be modified.

There are four sheets that show the present value of depreciation deductions per dollar 

invested:

B TxDeprPV_Ctot is for corporate investment using a typical mix of debt and 

equity financing.

B TxDeprPV_Cdt is for corporate investment using debt financing.

B TxDeprPV_Ceq is for corporate investment using equity financing.

B TxDeprPV_Ntot is for noncorporate investment using a typical mix of debt and 

equity financing.

The sheets are used to calculate average present values of depreciation deductions over 

all industries for each asset type. Industries are arrayed vertically over two pages; asset 

types are arrayed horizontally over five pages, as they are for the worksheet 

TxDeprMthd.

Each cell in TxDeprPV_Ctot that is associated with an industry and an asset class 

contains a present value of depreciation deductions per dollar invested. The value is 

drawn from the TxDeprFrml worksheet on the basis of instructions from the worksheet TxDeprMthd. For example, if cell C3 of TxDeprMthd contains a value of 

“sl_3,” then cell C3 in TxDeprPV_Ctot will, under current law, be fed a value of 

0.9005, because that is the content of the cell named “sl_3” (E37) in TxDeprFrml.

The other three sheets use different discount rates to calculate the present value. To 

identify the proper discount rate, a prefix is added to the method name identified in 

TxDeprMthd. For the Cdt sheet, the prefix is “D”; for Ceq, it is “E”; and for Ntot, it 

is “N.” Therefore, cell C3 of TxDeprPV_Cdt will, under current law, contain a value 

of 0.9330, because that is the content of the cell named “Dsl_3” (E38) in 

TxDeprFrml.

On row 67, a weighted-average present value is calculated for each nonresidential asset 

type using amounts from column B of NonresCapStk to derive the weights. The 

depreciation of the three types of residential assets cannot differ by industry. Therefore, the present values of tax depreciation for those asset types are entered directly on 

row 67. The values for all columns of row 67 are then fed into columns J–M of Full 

detail.