Decomposing the Welfare Costs of Capital Tax Distortions: The Importance of Risk Assumptions

This paper analyzes the implications of alterative risk assumptions for estimates of the distorting effects of the corporate tax in Canada. These distortions are decomposed into three broad categories: inter-asset distortions; inter-industry distortions; and inter-temporal distortions. Estimates of marginal effective corporate tax rates are used in a multi-asset general equilibrium model to evaluate the costs of the various distortions, with marginal effective tax rates calculated under alterative risk assumptions. Results indicate that assessments of the relative importance of these distortions are sensitive to alterative risk assumptions used in marginal tax rate calculations. The paper also explores the sensitivity of results to key elasticity parameters in the model.