Analyzing Tax Policy

Federal corporate income tax policy comprises laws and regulations that define income subject to taxation, adjustments to taxable income (deductions), tax rates, and adjustments to tax payments (tax credits and minimum tax payments). Tax code provisions are not just intended to raise revenue they are also structured to provide taxpayers with incentives to spend or invest in desirable ways. Most of these incentives are either deductions from taxable income or credits against tax liability. For example, the tax code contains tax credits to encourage firms to perform more R D and to make the United States competitive with other nations as a place to locate business. Similar tax deductions exist for some R D expenses not eligible for these tax credits. Because each of these provisions reduces the taxes that the Federal Government collects from firms, they are sometimes referred to as tax expenditures (241). While any taxpayer theoretically could take advantage of any of these incentives, in reality many provisions have requirements that preclude their use except by certain types of taxpayers. This review focuses on components of the tax code that either directly affect industrial 

1 This chapter is based in part on two papers prepared under contract for the Office of Technology Assessment (7,245). 

R D expenditures or are used by the pharmaceutical industry more (in terms of Federal tax expenditures) than by other industries. 

A common measure of the impact of tax policy on a firm s or industry s operation is the average effective tax rate, the ratio of actual income tax paid to the pretax income of a taxpayer or a group of taxpayers (such as the whole pharmaceutical industry). This measure of tax burden assesses the equity of taxes paid across different kinds of taxpayers or in examinations of corporate profits and profit rates. 

Because the average effective tax rate combines the effects of all provisions of the tax code, it obscures differences in the tax rate that apply to different kinds of assets or across different firms within an industry (7). This chapter does not contain estimates of average effective tax rates in the pharmaceutical industry, but it does contain estimates of each tax credit in the U.S. Federal Tax Code as a percent of the pharmaceutical industry s taxable income. This measure is the difference between two average effective tax rates the average rate without a credit minus the average rate with the credit. 

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