Introduction

The purpose of this chapter is to compute the effective marginal rate of taxation of capital income in Japan and to compare the result with the U.S. tax treatment of capital income. It is well known that the personal savings rate and the investment rate are quite high in Japan by international standards. This chapter attempts to investigate whether or not tax policies at both the personal level and the corporate level could be responsible for this high rate of capital accumulation.

In order to do this, we need to define precisely what we mean by the effective marginal rate of taxation of capital income. We follow the conventions of King (1977) and King and Fullerton (1984). We compute the wedge between the gross earnings of a marginal new investment and the net return that the investor earns. This wedge is then compared to the gross earnings of the investment to give us an effective rate of taxation. The result is a marginal rate, because it refers to the taxation of an incremental new investment. This marginal tax rate is to be contrasted with the frequently computed average tax rate, which is simply the ratio of taxes paid to gross earnings for all existing capital. Although we limit our analysis to capital in the corporate sector, we do not limit the analysis to the corporate tax. In fact, we include in the tax-wedge computation personal income taxes and wealth taxes, as well as the corporate income tax.