An Empirical Test for Forward Looking Measures of the Effective Tax Burden on Investment

Forward looking measures like the well-known effective marginal tax ratedeveloped by King and Fullerton (1984) are often criticized for not takinginto account the complexity of the tax law. This paper derives a method ofevaluating this kind of measure and of quantifying the bias resulting fromsimplifying assumptions, especially on the pattern of depreciationdeductions. We apply our method to German data and find that even smallestimation biases in determining the tax deductions have a large impact onthe effective tax rates for marginal and intramarginal investment projects.We conclude that our method may be used to quantify the difference between the actual use of depreciation deductions and the King-Fullerton assumptions and therefore to correct the conventional forward looking measures.