Taxes, Investment Incentives, and the Cost of Capital in Armenia

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category of assets and select industries in Armenia. ... A number of features of Armenian taxes embody differential tax levies. ..... 39 Electric light and power.

Working Paper No. 04/03

Taxes, Investment Incentives, and the Cost of Capital in Armenia David Joulfaian Office of Tax Policy, US Department of the Treasury and George Washington University [email protected]

Lilit Melikyan BearingPoint/USAID [email protected]

January 2004 Abstract This paper provides measures of the user cost of capital in Armenia. First, it provides a general overview of the various taxes that apply to capital. Then, using the Neoclassical model of investment, the features of the tax code are employed in calculating the cost of capital for a large category of assets and select industries in Armenia. Because, the tax treatment varies among assets and industries, we find quite a variation in the measured user costs and the implied marginal effective tax rates. These may have important implication for the allocation of investment in Armenia.

The views expressed in this Working Paper are those of the author(s) and do not necessarily represent those of the Armenian International Policy Research Group. Working Papers describe research in progress by the author(s) and are published to elicit comments and to further debate.

Journal of Economic Literature Classification: H21, H25, H32, D61 Keywords: Taxes, Cost of Capital, Investments, Distortions

The views expressed in this paper are those of the authors and do not necessarily reflect those of their respective institutions. I. Introduction

Taxes introduce a wedge between the rate of return on an investment and its after-tax rate of return. Thus taxes reduce the incentives to invest. Because taxes may apply unevenly to different assets and industries, they also are likely to distort the allocation of investments. There are general concerns related to whether high tax rates reduce business investments, or exacerbate misallocations of investments among the various sectors and/or assets. Over the past decade, the Armenian government embarked on a policy of liberalizing the tax code and reducing the profit tax. The incentive effects, however, have yet to be addressed. What are these long term effects, how much taxes contribute to the cost of capital, and how large are the potential distortionary effects? This paper makes a first attempt at examining the incentive effects of taxes that extend to capital investments in Armenia. In particular, it explores the effects of the Enterprise Profit and property taxes levied on business equipments and structures. The focus is on the long run, and abstracts from short term macroeconomic stabilization policies and temporary features of the tax code. Owners are assumed to maximize the value of their firms, and both the inflation and interest rates are assumed constant and fully anticipated. A number of features of Armenian taxes embody differential tax levies. Tax rates, for instance, may vary by industry and asset employed. Similarly, deductible expenses may vary by type of asset, industry, as well as geographic location. These features may have differential effects on measured incentives and effective tax rates on investments. While our ultimate goal is to quantify the potential effects of taxes, our short term goal is to explore the magnitude of the tax wedge. More specifically, in this paper we calculate and compare the cost of capital and effective tax rates across assets, industry, and geographic location. The stylized facts gleaned from the findings suggest that overall marginal effective tax rates are well below the statutory rates levied by the government. In addition, these rates 1

vary significantly, and range from zero in the case of computers to 15.3 percent on hotels with 13 percent for all assets. Similarly, rates vary by industry with the lowest for farmers. Geographically, investments in Gyumri face the lowest burden with rates close to zero; zero when property taxes are ignored. The remainder of the paper is organized as follows. Section II describes the general features of capital taxes in Armenia. Section III describes our model of investment incentives, and Section IV presents the results of our calculation of the effect of taxes on measured investment incentives. In Section V we summarize our findings. II. Capital Taxes in Armenia A. The Profit Tax The Armenian Enterprise Profit tax shares many of the features of corporate taxes levied around the world. Gross receipts of the firm, for instance, are reduced by expenses, such as wages, depreciation and amortization, interest payments, and so forth in determining taxable income. By applying to the latter a tax rate schedule, the tax liability is determined.

Tax rates Firms face a profit tax rate of 20 percent.1 Firms operating in the agricultural sector, however, are exempt from the profit tax.

Depreciation allowances Assets, other than inventory and land, fall into four categories. Some assets, such as computers, are expensed, (2) other machinery and equipment are depreciated straight line over 5 years, and (3) structures with 10 year lives, and (4) other structures with 20 year lives.

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B. Property Taxes The owners of real estate and motor vehicles are subject to annual property tax conceptually not much different from those encountered in the US. Taxes are based on value of buildings and structures. In the case of motor vehicles, the tax is based on the number of horsepowers.

Tax base The reach of property taxes extends to real estate structures, buses, trucks, cars, and boats.

Tax Rates A tax rate of 0.3 percent extends to structures. The tax on passenger servicing automobiles with up to 10 seats, the tax is: a.. 200, or 200 drams per horsepower, when under 120 horsepower b. 300 drams per horsepower, when between 120 and 250 horsepower c. 500 drams per horsepower, when 250 and more In case of passenger servicing automobiles with more than 10 seats and for the trucks, the tax is: 100 drams for each horsepower, when under 200 horsepower 200 drams per horsepower, when 200 horsepower and more Similar rules also apply to boats. C. Personal Income Tax The personal income tax exempts individual shareholder dividends, as well as individual capitals gains from business equity. D. Concessions and Preferential Treatments Armenia employs fiscal incentives to channel and stimulate domestic and foreign investment. Tax concessions may vary by sector, type of assets invested in, and 1 We abstract from the minimum profit tax introduced recently (1% of turnover).

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discriminate among domestic and foreign investors. These breaks take a number of forms, summarized below.

Tax holidays Through 2007, foreign companies with investing $850,000 (500M AMD) are fully exempt fro the profit tax for two years.

Reduced corporate income tax rates Zero profit tax rate for agricultural firms.

Accelerated depreciation allowances Assets, other than inventory and land, fall into four categories. Some assets, such as computers, are expensed, (2) other machinery and equipment are depreciated straight line over 5 years, and (3) structures with 10 year lives, and (4) other structures with 20 year lives. The tax code provides accelerated depreciation allowances for a number of equipments and structures. The cost of acquiring computers can be expensed. In another example, hotels may be depreciated over a period of 10 years. Table 1 provides a summary of the lives that the tax codes extends to a number of assets and industries. In addition, the tax code provides preferential treatment of to the earthquake zone. Transmission devices, buildings and hotels, and other fixed assets, which are located in the disaster area may be expensed. For organizations operating in the city of Gyumri, the minimum depreciation period of buildings, constructions, transmission devices, production lines, robotics and other fixed assets located in Gyumri shall be determined as 1 year. III. Measuring investment incentives 4

We employ an investment incentive model based on the neoclassical rental rate approach of Hall and Jorgenson (1967). It captures the effects of various provisions of the Armenian tax code, but abstracts from risk. Taxes differ from asset to asset, and also by industry. A. The cost of capital The neoclassical approach exploits the competitive profit maximizing condition that the marginal investment will yield a cash flow whose present value is at least equal to its acquisition price, q. At equilibrium, the two are equal, or: (1)

q=





0

(1 − u ) ce ( π − δ ) t e − i (1− u ) t dt + uzq

This equilibrium is solved for the cost of capital c/q, (2)

c r −π +δ = (1 − uz ) q 1− u

where r is the firm's nominal discount rate, π is the (constant) expected rate of inflation, δ is the geometric rate of economic depreciation, u is the statutory profit tax rate, and z is the present value of tax depreciation allowances on 1 Dram basis. This measure of the cost of capital is commonly used in econometric analysis of the determinants of investments. However, such a measure is not useful is measuring effective tax rates or measuring the efficiency implications of taxes. Uniform costs of capital, for instance, do not imply tax neutrality. Instead we estimate the social return on investment variant of the cost of capital, which is also gross of tax but net of economic depreciation, c/q-δ. For a firm, the cost of capital on a marginal investment of 1 Dram, ρ, 5

is (3)

ρ=

r −π +δ (1 − uz ) − δ 1− u

Equation (3) can be further modified to include property taxes at rate w, as in Fullerton (1985); (4)

ρ=

r −π +δ (1 − uz ) + w − δ 1− u

as well as sales taxes when extended to investment goods as in Joulfaian and Mackie (1992).2 The discount and inflation rates are constant across all assets. The other parameters (u, z, w, and δ) vary by asset and industry. B. The discount rate The discount rate, r, is defined as the firm’s after-tax tax risk free rate of return. It represents the minimum after-corporate tax return which would allow the ultimate investor to pay his tax, and still leave him with his required after-tax rate of return. In effect, this is the firm’s opportunity cost to invest. Conceptually, the discount rate may depend on the source of financing (debt, retained earnings, and new share issues). In the case of debt, for instance, the corporation's nominal discount rate is simply its after-tax interest cost: r= i(1-u) For retained earnings, the investment earns a nominal net-of-corporate-tax return and the resulting share appreciation is taxed at the accrued personal capital gains tax rate τcg. 2 To our knowledge, Armenia does not tax investment goods. In the event of a nonrefundable VAT, the tax may extend its reach to capital goods.

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r = i(1-u)/(1-τcg) Finally, new share issues provide an after-corporate-tax return that is paid as dividends and taxed at the personal rate tns: r = i(1-u)/(1-τns) In the absence of individual dividend and capital gains taxes, the nominal discount rate simplifies to r=i(1-u). The real discount rate, or the real opportunity cost to the firm, is defined as: (5)

s = r −π

C. Effective Tax Rates As an alternative to the cost of capital, and in order to simplify the presentation, effective tax rates are reported. Investment incentives are properly measured by the cost of capital, ρ, but we also report our results in terms of marginal effective total tax rates to simplify the presentation. These tax rates are the difference between the pre- and post-tax rates of return, as a proportion of the pre-tax rate of return. The marginal effective total tax rate shows the portion of marginal capital costs attributable to taxes. (6)

τ=

ρ −s ρ

D. Data and parameters Our analysis requires information on statutory income tax rates, economic depreciation rates, capital cost recovery allowances, financing shares, property tax rates, inflation, and 7

the real after-tax and risk-free rate of return.

Statutory profit tax rates -- u We set the corporate tax rate, u, equal to 0.20. In the case of farms, it is set equal to zero. Economic depreciation -- δ For each of 28 types of equipment and 12 types of structures, we use economic depreciation rates, δ, as computed by the US Department of Commerce, Bureau of Economic Analysis (1997). In many ways these are similar, or build upon those, reported Hulten and Wykoff (1981). These are summarized in column 1 of Table 1.

Capital cost recovery allowances -- d To estimate the present value of depreciation allowances (z), we classify assets into statutory depreciation categories, and then calculate z using methods prescribed by law, and applying the discount rate, r. The tax lives provide under Armenia’s profit tax are reported in the middle panel of Table 1. Capital expenditures are expensed over these lives using straight line method. All investments in Gyumri are expensed. The same exemption is extended to investment in structures in the earthquake zone. Investments in equipment, however, are accorded the general treatment, as captured in Table 1.

Property tax rate – w Property tax rates are reported in Table 2. All equipments are exempt from taxation, except for buses, truck, cars, and boats. The tax code does not provide a specific tax rate for the latter. These are computed by considering the price of the vehicles, the 8

horsepower, and applicable per unit tax, or: Tax rate = (tax per horsepower*number of horsepowers) / price These rates actually vary considerably, as the underlying prices of the vehicles change. The tax rates on trucks, buses, and cars are set at 1 percent, with 0.4 percent for boats.

Other parameters We set the inflation rate, π, to 3 percent, and the after-tax risk free discount rate, r, to 7 percent (s=0.04). As eluded to earlier, the discount rate depends on the tax-free measure of long term interest rates. Yet such measures are not readily available for Armenia. Notwithstanding this assumption, however, we do experiment with alternative values.3 IV. Effect of taxes on measured investment incentives Equipped with the various parameters above, estimating (4) and (6) for a specific asset in a given industry is straightforward. What we need, however, are nationwide estimates aggregated at the asset and industry levels. Information needed to generate such estimates is not available for Armenia. Instead, we rely on US data on capital assets by type and industry published by the Commerce Departments Bureau of Economic research. However, while this solves a computational problem, it may introduce measurement errors as the structures of the two economies vary drastically. With the above shortcomings in mind, we narrow our focus to 10 somewhat broadly defined sectors of the economy. These include farms, metal mining, construction, food manufacturing, telecommunication, utilities, trade, hotels, business services, and health services. In addition to these industry mix and technology assumptions, we make a number of assumptions to facilitate the analysis. We assume that firms are able to take advantage of

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all tax preferences and comply with the prevailing tax code. Similarly, we assume that the tax code is uniformly applied, without any preferential treatments or governance anomalies. For each asset, we the cost of capital and the implied effective tax rate, as in (4) and (6). For the former, we also compute the coefficient of variation. With fully uniform taxation, all investments would have the same cost of capital (and effective tax rate), and the coefficient of variation in the cost of capital would be zero. Non-uniform taxes create differences in the cost of capital across assets and sectors and thereby raise the coefficient of variation. A lower coefficient of variation means less disparity in the tax treatment of alternative investments; a reduction in the coefficient of variation shows a leveling of the playing field.

Inter-asset disparities Table 3 reports industry-weighted estimates of the cost of capital and effective tax rates for 28 types of equipments and 12 structures. Estimates for select assets are reported in Figure 1. The coefficient of variation calculation in the bottom of the table offers a helpful summary of tax induced variation in investment incentives. Beginning with computers, the cost is 4 percent, exactly equal to the real discount rate. Thus, computers face a tax rate of zero. Indeed, Table 3 points to considerable variations in tax rates. While the unweighted average tax rate is 13 percent, instruments as with computers face a tax rate of zero. In contrast, automobiles face the highest tax rate. In the case of structure, tax rates hover around 15 to 20 percent, except in the case of farm structures which face a rate of 7 percent. The coefficient of variations is 9.2 percent.

3 We abstract from general equilibrium effects, and hold the discount rate constant.

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Figure 1. Marginal Effective Tax Rates for Select Assets: Profit and Property Taxes 35.0% 30.0%

Tax Rate

25.0% 20.0% 15.0% 10.0% 5.0%

ur es

s

str uc t

ctu re tru

.s om m Te

lec

Fa rm

els Ho t

ui ld in gs

in gs

ce b

Of fi

bu ild In du str ial

Co m Co pu m te m rs El un ec ic tri ati ca on lt ra eq ns . m iss i on Tr eq uc . ks an db Ho us us es eh ol d fu rn itu re Fa rm tr a ct or s

0.0%

Geographic disparities Given limited resources at the disposal of the government, the tax code is used as a mechanism to direct investment to certain regions. The government may deem the welfare gains from improved economic performance in these regions to outweigh the losses from the efficiency losses from the misallocation of resources. Gyumri and the earthquake zone are such regions in Armenia. Table 5 and Figure 2 report cost of capital and tax rate measures aggregated at the equipment and structures level. In Gyumri, the effective tax rate is a mere fraction of tax that faced by firms under the general tax code. Estimates for the earthquake zone fall somewhere in between.

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Figure 2. Marginal Effective Tax Rates: Profit and Property Taxes

Tax Rate

20.0% 15.0% 10.0% 5.0% 0.0% Armenia Equipment

Gyumri Structures

Earthquake Zone

Total

Inter-sectoral disparity The third type, inter-sectoral disparity, is caused by cross-sector differences in the taxation of the same investments employed across different sectors of the economy. Because of the rate differentials, and as shown in Table 6 and Figure 3, farms face an effective marginal tax rate of 5.3 percent compared to 15 percent for telecommunications. The coefficient of variation is about 4 percent, and relatively small. The disparity at the asset level seems to be greater than those at the industry level.

Estimates without property taxes To examine the effects of the profit tax in isolation of property taxes, Table 4 is reestimated by setting the latter to zero. Revised estimates are reported in Table 6 and Figure 4. All effective tax rates, as gleaned from the result, are well below the statutory profit rate of 20 percent; zero in Gyumri.

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H

ea

lth

Se r

vi ce

s

s ss Se rv ic e

ot els

Bu sin e

H

e Tr ad

s U

til iti e

le ph on e Te

M

an

uf a

tio n Fo od

Co ns tru c

in in g

M

et al

M

Fa r

ct ur in g

20.0% 18.0% 16.0% 14.0% 12.0% 10.0% 8.0% 6.0% 4.0% 2.0% 0.0% m s

Tax Rate

Figure 3. Marginal Effective Tax Rates: Profit and Property Taxes

Figure 4. Marginal Effective Tax Rates: Profit Tax only

14.0% 12.0% Tax Rate

10.0% 8.0% 6.0% 4.0% 2.0% 0.0% Armenia

Gyumri

Equipment

Structures

Earthquake Zone

Total

Alternative discount rate assumption We experiment with alternative value of the discount rate. The earlier rate of 7 percent is 13

now reduced to 6 percent. The earlier estimates of Table 5 and 6 are not updated using the new parameter, and the revised estimated reported in Tables 7 and 8. The lower discount rate assumption reduced the measured cost of capital. Not surprisingly, this leads to a greater measure of the estimated marginal effective tax rate. The disparity in tax rates and cost of capital continues to manifest itself in the reported figures. One of the interesting implication of this exercise, is that the effects of the one percentage point reduction in the discount rate reduces the cost of capital by more than the effects of the full repeal of the profit tax. This highlights the importance of monetary policy, and reflects the fact that such effects may swamp those of tax policy.

Tax evasion Some industries are more prone to tax evasion than other. Detection rates for evaded income in cash based industries, for instance, might be very low. To the extent that not all firms are equally prone to evasion, either to varying detection rates or simply reflecting managerial preferences (Joulfaian, 2000) or in response to differential taxation (Joulfaian and Rider, 1998), evaded capital income may affect the measurement of the cost of capital and effective tax rates and lead to greater misallocation of resources (Fullerton and Karajan’s, 1994).

Tax Offsetting Government Programs At times governments provide indirect subsidies or in kind benefits to induce investments. These, for instance, may take the form of constructing a new ramp for better access to a highway, or relaxing some existing regulation among others. The benefit form some of these acts may offset a fraction, if not exceed, the entire initial investment. Consider the case of TWT, which bought 49 percent ownership interest in Argental, the state owned telecom, in 1994. In 1995, the government granted the jointly owned firm 14

monopoly rights in the entire telecom sector, include the internet and cable. This was granted without any compensation fromTWT or dilution in its ownership interest. Judging from the sale proceeds of Armentel in February of 1998, TWT received close to five folds its initial investment. The effective tax rate in the case of TWT is certainly negative. More importantly, the proceeds at stake represented 2-3 times the entire yield of the profit tax.

Tax administration implications The true scope of the incentives, or the reach of the tax code, is predicated on the uniform enforcement and administration of the applicable tax laws. Uneven enforcement, however, may have significant effects on the disparity of the measured cost of capital and marginal effective tax rates. Again consider the case of TWT. The initial invest of $10.25 million in 1994 appreciated significantly in part due to the uncompensated grant of monopoly rights. These accrued gains would become taxable in the event of the sale of the firm. Yet when Armentel was sold to the Hellenic OTE in February 1998, TWT was not assessed any capital gains taxes even though a government representative set at the same table when the proceeds were disbursed By 2000, the amount of taxes and penalties amounted to $12 million (US Securities and Exchange Commission, Form 20). Uneven tax administration may not only take the form of arbitrary “forgiveness” of taxes, but it may also extract payment of taxes and penalties where income and tax liability do not exist in the first place. Early in 2000, Armenian authorities levied and extracted the $12 in unpaid taxes and penalties from OTE even though the gains were accrued by TWT (US Securities and Exchange Commission, Form 20). V. Summary and conclusion

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The stylized facts gleaned from the findings suggest that overall marginal effective tax rates are well below the statutory rates levied by the government. In addition, these rates vary significantly, and range from zero in the case of computers compared to 13 percent for all assets. Similarly, rates vary by industry with the lowest for farmers. Geographically, investments in Gyumri face the lowest burden with rates close to zero; zero when property taxes are ignored. While the disparity in effective tax rates vary by industry and type of asset and may have significant allocation implications, these effects may be overwhelmed by monetary policy. A reduction of one percentage point in the discount rate, for instance, is shown to reduce the cost of capital by more than the repeal of the entire profit tax. One important caveat about our findings is that they are likely to be subject to measurement errors in the presence of poor and uneven administration of the tax code. This is a first step in evaluating the incentive effects of capitals taxes in Armenia. There are a number of data shortcomings that need to be overcome. US data on the allocation of assets by type and industry are likely to be poor proxies for Armenia. Pending the development such data, weighted measures of the cost of capital and effective tax rates should be viewed as tentative as they are likely to suffer from measurement errors. Furthermore, and to allow for better measurement of incentives, we need data on the geographic allocation of assets as well. Once these measurement issues are tackled, the next step should include the development of general equilibrium models for use to gauge the magnitude of the welfare loss to the society from tax induced distortions.

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References Auerbach, Alan J. (1979), "Wealth Maximization and the Cost of Capital," Quarterly Journal of Economics 93, August, 433-46. Auerbach, Alan J. (1983), "Corporate Taxation in the Equilibrium Approach," Journal of Public Economics 20, February, 3 23. Auerbach, Alan J. (1984), "Taxes, Firm Financial Policy, and the Cost of Capital: An Empirical Anal Structures," in M. Feldstein, ed. The Effects of Taxation on Capital Accumulation, Chicago: University of Chicago Press. Fullerton, Don and Yolanda K. Henderson (1985) "Long Run Effects of the Accelerated Cost Recovery System," Review of Economics and Statistics 67, August, 363-72. Fullerton, Don and Yolanda K. Henderson (1989), "A Disaggregate Equilibrium Model of the Tax Distortions Among Assets, Sectors, and Industries," International Economic Review, May. Fullerton, Don and Marios Karayannis, (1994). “Tax Evasion and the Allocation of Capital,” Journal of Public Economics, Vol 55, no. 2, October, 257-278 Fullerton, Don and Andrew B. Lyon (1988), "Tax Neutrality and Intangible Capital," in L. Summers, ed. Tax Policy and the Economy 2, Cambridge, MA: MIT Press. Fullerton, Don, Robert Gillette, and James Mackie (1987), "Investment Incentives Under the Tax Reform Act of 1986," in Compendium of Tax Research, Washington DC: U.S. Treasury Department. Hall, Robert E. and Dale W. Jorgenson (1967), “Tax Policy and Investment Behavior,” American Economic Review, vol 57, June, 391-414. Hulten, Charles R. and Frank C. Wykoff (1981), “The Measurement of Economic Depreciation,” in Charles R. Hulten, ed., Depreciation, Inflation, and Taxation of Income from Capital, the Urban Institute, Washington, DC. Jorgenson, Dale W. and Martin Sullivan (1981), “Inflation and Corporate Capital Recovery,” in Charles R. Hulten, ed., Depreciation, Inflation, and Taxation of Income from Capital, the Urban Institute, Washington, DC. Joulfaian, David (2000), "Corporate Tax Evasion and Managerial Preferences," The Review of Economics and Statistics 82:4, November, pp. 698-701 Joulfaian, David, and Mark Rider (1998). "Differential Taxation and Small Business Tax 17

Evasion," National Tax Journal 51:4, December, pp. 675-687 Joulfaian, David and James Mackie (1992), "Sales Taxes, Investment, and the Tax Reform Act of 1986," National Tax Journal 45:1,March, pp. 89-106 US Securities and Exchange Commission. Hellenic OTE, Form 20, Various years. King and Fullerton (1994) Incomplete

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Table 1. Economic and Tax Depreciation Allowances by Type of Asset

Equipment 1 Computers 2 Communication equipment 3 Instruments 4 Photocopy and related equipment 5 Office and accounting equipment 6 Other fabricated metal products 7 Steam engines 8 Internal combustion engines 9 Metalworking machinery 10 Special industry machinery 11 General industrial machinery 12 Electrical transmission & 13 14 15 16 17 18 19 20 21 22 23

distribution Trucks, buses, and truck trailers Autos Aircraft Ships and boats Railroad equipment Household furniture Other furniture Farm tractors Construction tractors Agricultural machinery, except tractors Construction machinery, except tractors Mining and oilfield machinery Service industry machinery Household appliances Other electrical equipment Other nonresidential equipment

24 25 26 27 28 Structures 29 Industrial buildings 30 Office buildings 31 Commercial warehouses 32 Other commercial buildings 33 Educational 34 Hospitals 35 Hotels 36 Amusement and recreational 37 Other nonfarm buildings 38 Telecommunications structures 39 Electric light and power 40 Mining exploration

Economic Depreciation Rate (δ)

Economic Life

Tax Depreciation Rate (d)

Tax Life

0.3119 0.1500 0.1350 0.1800 0.3119 0.0917 0.0516 0.2063 0.1225 0.1031 0.1072 0.0500

? 11 12 9 7 18 32 8 16 16 16 33

1.000 0.200 1.000 1.000 1.000 0.200 0.200 0.200 0.200 0.200 0.200 0.200

1 5 1 1 1 5 5 5 5 5 5 5

1.000 0.200 1.000 1.000 1.000 0.200 0.200 0.200 0.200 0.200 0.200 0.200

1 5 1 1 1 5 5 5 5 5 5 5

0.1725 0.3330 0.0825 0.0611 0.0589 0.1375 0.1179 0.1452 0.1633 0.1179

10 ? ? 27 28 12 14 9 8 14

0.200 0.200 0.200 0.200 0.200 0.200 0.200 0.200 0.200 0.200

5 5 5 5 5 5 5 5 5 5

0.200 0.200 0.200 0.200 0.200 0.200 0.200 0.200 0.200 0.200

5 5 5 5 5 5 5 5 5 5

0.1550

10

0.200

5

0.200

5

0.1500 0.1650 0.1640 0.1834 0.1473

11 10 10 9 11

0.200 0.200 0.200 0.200 0.200

5 5 5 5 5

0.200 0.200 0.200 0.200 0.200

5 5 5 5 5

0.0314 0.0247 0.0222 0.0262 0.0188 0.0188 0.0281 0.0300 0.0249 0.0237 0.0211 0.0450

31 36 40 34 48 48 32 30 38 40 45 38

0.050 0.050 0.050 0.050 0.100 0.100 0.100 0.050 0.050 0.050 0.050 0.050

20 20 20 20 10 10 10 20 20 20 20 20

1.000 1.000 1.000 1.000 1.000 1.000 1.000 1.000 1.000 1.000 1.000 1.000

1 1 1 1 1 1 1 1 1 1 1 1

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Earthquake Depreciation Tax Rate (d) Life

Table 2. Property Tax Rates by Type of Asset Rates Equipment Computers Communication equipment Instruments Photocopy and related equipment Office and accounting equipment Other fabricated metal products Steam engines Internal combustion engines Metalworking machinery Special industry machinery General industrial machinery Electrical transmission & distribution Trucks, buses, and truck trailers Autos Aircraft Ships and boats Railroad equipment Household furniture Other furniture Farm tractors Construction tractors Agricultural machinery, except tractors Construction machinery, except tractors Mining and oilfield machinery Service industry machinery Household appliances Other electrical equipment Other nonresidential equipment Structures Industrial buildings Office buildings Commercial warehouses Educational buildings Hospitals Hotels Other nonfarm buildings Farm Structures Telecommunications structures Wire and cable structures Electric light and power Mining exploration, other than oil/gas

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0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.010 0.010 0.000 0.004 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.003 0.003 0.003 0.003 0.003 0.003 0.003 0.003 0.000 0.000 0.000 0.000

Table 3. Effect of Profit and Property Taxes on Measured Investment Incentives Equipment 1 Computers 2 Communication equipment 3 Instruments 4 Photocopy and related equipment 5 Office and accounting equipment 6 Fabricated metal products 7 Steam engines 8 Internal combustion engines 9 Metalworking machinery 10 Special industry machinery 11 General industrial machinery 12 Electrical transmission & distribution 13 Trucks and buses 14 Autos 15 Aircraft 16 Ships and boats 17 Railroad equipment 18 Household furniture 19 Other furniture 20 Farm tractors 21 Construction tractors 22 Agricultural machinery, except tractors 23 Construction machinery, except tractors 24 Mining and oilfield machinery 25 Service industry machinery 26 Household appliances 27 Other electrical equipment 28 Other nonresidential equipment Structures 29 Industrial buildings 30 Office buildings 31 Commercial warehouses 32 Other commercial buildings 33 Hospital and institutional buildings 34 Hotels and motels 35 Amusement and recreational buildings 36 Other nonfarm buildings 37 Telecommunications structures 38 Electric light and power 39 Farm related buildings and structures 40 Mining exploration, other then oil/gas Average (unweighted) Coefficient of Variation

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ρ Cost of Capital

τ Marginal Effective Tax Rate

0.0400 0.0458 0.0400 0.0400 0.0400 0.0438 0.0428 0.0472 0.0442 0.0444 0.0445 0.0428 0.0560 0.0611 0.0437 0.0472 0.0430 0.0454 0.0448 0.0407 0.0462 0.0402 0.0460 0.0458 0.0462 0.0461 0.0466 0.0456

0.0000 0.1269 0.0000 0.0000 0.0000 0.0873 0.0655 0.1524 0.0956 0.0986 0.1011 0.0644 0.2659 0.3456 0.0856 0.1523 0.0704 0.1185 0.1072 0.0162 0.1347 0.0044 0.1298 0.1270 0.1350 0.1324 0.1416 0.1226

0.0507 0.0500 0.0497 0.0502 0.0467 0.0472 0.0506 0.0500 0.0469 0.0466 0.0430 0.0492 0.0460 0.0920

0.2116 0.2001 0.1958 0.2027 0.1426 0.1531 0.2092 0.2005 0.1471 0.1420 0.0699 0.1871 0.1304

Table 4. Summary of Effect of Taxes on Measured Investment Incentives* .

General Equipment Structures Total Gyumri Equipment Structures Total Earthquake Zone Equipment Structures Total

ρ Cost of Capital

τ Marginal Effective Tax Rate

0.0449 0.0480 0.0468

0.1195 0.1667 0.1445

0.0411 0.0420 0.0416

0.0267 0.0481 0.0396

0.0449 0.0420 0.0432

0.1195 0.0481 0.0738

*Combined effects of profit tax, accelerated depreciation, expensing, and property taxes. Investments in equipment and structures in Gyumri are expensed. Investments in structures in the earthquake zone are also expensed, but investments in equipment are accorded the general depreciation treatment.

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Table 5. Summary of Effect of Taxes on Measured Investment Incentives by Industry Industry

ρ Cost of Capital

τ Marginal Effective Tax Rate

Farms Metal Mining Construction Food Manufacturing Telephone Utilities Trade Hotels Business Services Health Services Average (unweighted) Coefficient of Variation

0.0422 0.0489 0.0490 0.0472 0.0469 0.0458 0.0485 0.0471 0.0458 0.0457 0.0467 0.0408

0.0529 0.1813 0.1840 0.1521 0.1478 0.1268 0.1752 0.1500 0.1265 0.1250 0.1437

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Table 6. Summary of Effect of Taxes on Measured Investment Incentives* (Property taxes set to zero)

General Equipment Structures Total Gyumri Equipment Structures Total Earthquake Zone Equipment Structures Total

ρ Cost of Capital

τ Marginal Effective Tax Rate

0.0438 0.0460 0.0451

0.0954 0.1301 0.1132

0.0400 0.0400 0.0400

0.0000 0.0000 0.0000

0.0438 0.0400 0.0415

0.0954 0.0000 0.0371

*Combined effects of profit tax, accelerated depreciation, and expensing. Do not reflect effects of property taxes. Investments in equipment and structures in Gyumri are expensed. Investments in structures in the earthquake zone are also expensed, but investments in equipment are accorded the general depreciation treatment.

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Table 7. Summary of Effect of Taxes on Measured Investment Incentives* (Reduce discount rate by one percentage point)

General Equipment Structures Total Gyumri Equipment Structures Total Earthquake Zone Equipment Structures Total

ρ Cost of Capital

τ Marginal Effective Tax Rate

0.0342 0.0366 0.0356

0.1236 0.1801 0.1582

0.0311 0.0320 0.0316

0.0352 0.0632 0.0521

0.0342 0.0320 0.0329

0.1236 0.0632 0.0886

* Combined effects of profit tax, accelerated depreciation, expensing, and property taxes. Investments in equipment and structures in Gyumri are expensed. Investments in structures in the earthquake zone are also expensed, but investments in equipment are accorded the general depreciation treatment.

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Table 8. Summary of Effect of Taxes on Measured Investment Incentives by Industry (Reduce discount rate by one percentage point) Industry Farms Metal Mining Construction Food Manufacturing Telephone Utilities Trade Hotels Business Services Health Services Average (unweighted)

ρ Cost of Capital

τ Marginal Effective Tax Rate

0.0322 0.0373 0.0379 0.0360 0.0357 0.0345 0.0372 0.0360 0.0349 0.0348 0.0357

0.0693 0.1957 0.2080 0.1665 0.1589 0.1298 0.1933 0.1675 0.1412 0.1390 0.1586

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