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Tax Progressivity and the Design of Tax Incentives for Investment

Author

Listed:
  • Jane G. Gravelle

    (Cengressional Research Service)

  • Dennis Zimmerman

    (Cengressional Research Service)

Abstract

This article uses marginal tax rate analysis to simulate the effect of our complex system of capital income taxation on of tertax returns by asset type and on tax progressivity. Preferential taxation is found to favor higher income individuals, causing returns to decline less steeply across the rate brackets, For any level of subsidy, the benefits to higher income investors are less pronounced when credits rather than deductions are used, suggesting that tax subsidies can be designed to reallocate investment without heavily favoring wealthy individuals. With leveraging, aftertax returns rise across the tax brackets for preferentially treated assets, suggesting the current tax rules produce regressive rather than progressive tax rates on capital income. The tax advantages of leveraging to high-bracket taxpayers persist when risk is introduced, as yield rises proportionally more than risk at high tax rates. Allowing for risk aversion also indicates that the timing of tax benefits affects an asset's riskiness, suggesting that tax subsidies can be designed both to achieve distributional objectives and to minimize private riskiness.

Suggested Citation

  • Jane G. Gravelle & Dennis Zimmerman, 1984. "Tax Progressivity and the Design of Tax Incentives for Investment," Public Finance Review, , vol. 12(3), pages 251-289, July.
  • Handle: RePEc:sae:pubfin:v:12:y:1984:i:3:p:251-289
    DOI: 10.1177/109114218401200301
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    References listed on IDEAS

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    1. Mervyn A. King, 1974. "Taxation and the Cost of Capital," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 41(1), pages 21-35.
    2. Miller, Merton H, 1977. "Debt and Taxes," Journal of Finance, American Finance Association, vol. 32(2), pages 261-275, May.
    3. Bailey, Martin J, 1974. "Progressivity and Investment Yields under U.S. Income Taxation," Journal of Political Economy, University of Chicago Press, vol. 82(6), pages 1157-1175, Nov.-Dec..
    4. Stiglitz, Joseph E., 1973. "Taxation, corporate financial policy, and the cost of capital," Journal of Public Economics, Elsevier, vol. 2(1), pages 1-34, February.
    5. Feldstein, Martin S, 1976. "Personal Taxation and Portfolio Composition: An Econometric Analysis," Econometrica, Econometric Society, vol. 44(4), pages 631-650, July.
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    Cited by:

    1. Alou Adesse Dama & Gregoire Rota-Graziosi & Faycal Sawadogo, 2024. "The regressivity of CIT exemptions in Africa," International Tax and Public Finance, Springer;International Institute of Public Finance, vol. 31(3), pages 909-934, June.
    2. Harvey Galper & Eric Toder, 1984. "Transfer Elements in the Taxation of Income from Capital," NBER Chapters, in: Economic Transfers in the United States, pages 87-138, National Bureau of Economic Research, Inc.

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