Implicit, Explicit and Total Tax

Implicit, Explicit and Total Tax

1. Explicit Tax

   • Tax paid directly to the government
   • It's the difference between the assets pre tax and post tax, rate of return
     • Pre tax rate of return is 10% (Ra)
     • Post tax rate of return is 7% (ra)
     • Explicit tax = (Ra-ra)=3%
   • Explicit tax rate is therefore (Ra - ra)/Ra

2. Implicit Tax

   • 2 assets with identical pre tax flows but cash flows from 1 asset are taxed more favourably, taxpayers will bid for the right to have this
     • As a result the tax favoured asset price increases, if the price increases the returns decrease
   • The reduction (increase) in an assets pre-tax rate of return resulting from its favorable (unfavorable) tax treatment
   • Calculating
     • Difference between a benchmark and a tax favoured asset
       • (Rb - Rf) = 3%
         • Implicit tax on a tax exempt asset
       • (Rb - Rb) = 0%
         • Implicit tax on a benchmark asset
     • Pre-tax return on a benchmark is 10%=Rb
     • Pre-tax return on tax exempt asset is 7%=Rf
   • Implicit tax is paid to issuers of tax favoured assets (via increased prices)
   • Implicit Rate
     • When applied to Benchmark leave a return equal to the before tax rate of return on the alternative investment, the tax free asset
     • (Rb - Rf)/Rb
       • (10 - 7)/10 = 30%
     • Paying a tax rate of 30% on benchmark would result in a turn of 7% as the Rf

3. Benchmark Asset

   • Fully taxed asset

4. Tax favoured asset

   • taxed more lightly than a benchmark asset
     • if highly not favoured asset disfavoured
   • Types
     • full tax exemption, partial exemption, lower marginal tax rate and tax credits

5. Total tax

   • In a competitive equilibrium the after tax returns on all assets must be equal and this implies that total tax must be the same
     • total tax = implicit tax +explicit tax
       • total tax for both assets is 3%
   • Rate
     • = implicit rate + explicit rate