The document discusses how the Congressional Budget Office (CBO) analyzes the tax burden on investments in intangible assets such as research and development, entertainment properties, and advertising. The CBO calculates effective tax rates and tax wedges under pre-2018 tax law and provisions of the 2017 tax reform act. It also accounts for multi-year development periods and risk of failure using a "success state" analysis. The CBO finds that tax burdens on most intangible assets declined under the 2017 act, but the burden on research and development will increase starting in 2022 when expensing is replaced with 5-year amortization.

1. Congressional Budget Office
National Tax Association
111th Annual Conference on Taxation
November 16, 2018
Paul Burnham
Tax Analysis Division
How Taxes Affect the Incentive to Invest
in New Intangible Assets

2. 1
CBO
In Taxing Capital Income: Effective Marginal Tax Rates
Under 2014 Law and Selected Policy Options, the
Congressional Budget Office calculated the tax burden
on income from investments in tangible assets.
In this report, CBO extends that analysis to
investments in intangible assets.
Congressional Budget Office, Taxing Capital Income: Effective Marginal Tax Rates Under 2014 Law and Selected Policy Options
(December 2014), www.cbo.gov/publication/49817.

3. 2
CBO
Distribution of Business Investment Among Structures, Equipment,
and Intellectual Property Products, 1966 to 2016

4. 3
CBO
Detailed equations can be found in Congressional Budget Office, Taxing Capital Income: Effective Marginal Tax Rates Under 2014 Law and
Selected Policy Options (December 2014), Appendix A, www.cbo.gov/publication/49817.
 The tax wedge:
– The before-tax rate of return that must be achieved to justify an investment
minus the after-tax rate of return
 The effective tax rate:
– The tax wedge divided by the before-tax rate of return
Measures of the Tax Burden

5. 4
CBO
 Taxes included for C corporations:
– Corporate income taxes
– Individual income taxes on interest, dividends, and capital gains
 Taxes included for pass-through entities:
– Individual income taxes
– Self-Employment Contributions Act (SECA) taxes on pass-though income
of sole proprietors and general partners
 Taxes excluded from analysis:
– Estate and gift taxes
– State and local taxes
Taxes Included in Measures of the Tax Burden

6. 5
CBO
 Prospective marginal investments (that is, those that are expected to just break
even)
 Investments by established profitable companies
 Investments in five types of intangible assets:
– Purchased software
– Assets resulting from research and development
– Entertainment, literary, and artistic originals
– Assets derived from mineral exploration and development
– Brand identity arising from advertising
Types of Investments to Which Measures of the Tax Burden Apply

7. 6
CBO
Analysis of the Permanent Features
of Pre-2018 Law

8. 7
CBO
a. Bonus depreciation for purchased software is not included because it was scheduled to expire in 2020.
b. Expensing of $15 million of movie development costs is not included because it was scheduled to expire in 2018.
Asset Type Predominant Cost-Recovery Method
Purchased Software Three-year amortizationa
Research and Development Expensing and the research and experimentation
credit
Entertainment, Literary, and Artistic
Originals
Income forecast method (which recovers costs at
roughly the rate of assets’ economic depreciation)b
Mineral Exploration and
Development
Expensing (except for 30 percent of investment by
integrated oil and gas companies, which is
amortized over five years)
Brand Identity Arising From
Advertising
Expensing
Cost-Recovery Methods Under the Permanent Provisions
of Pre-2018 Law

9. 8
CBO
Effective Tax Rates and Tax Wedges, by Type of Intangible Asset
Effective Tax Rate
(Percent)
Tax Wedge
(Percentage points)
All Intangible Assets 3 0.1
Purchased software 37 2.5
Research and development -31 -1.0
Entertainment, literary, and artistic originals 31 1.8
Mineral exploration and development 6 0.3
Brand identity arising from advertising -2 -0.1
All Tangible Assets 28 1.6

10. 9
CBO
Analysis of the 2017 Tax Act

11. 10
CBO
 Provisions affecting intangible assets only:
– Temporary expansion of bonus depreciation to include development and
production of motion pictures and television programs
– Five-year amortization of research and development expenses beginning in 2022
– Reduction in the orphan drug credit
 Provisions affecting both intangible and tangible assets:
– Permanent reduction of the corporate income tax rate to 21 percent
– Permanent increase in section 179 expensing
– Temporary increase in bonus depreciation
 Provisions affecting both intangible and tangible assets but excluded from analysis:
– Temporary reduction in the individual income tax rate
– 20 percent deduction for pass-through entities
– Limits on interest deductibility
Provisions of the 2017 Tax Act That Affect Intangible Assets

12. 11
CBO
a. CBO’s computations account for only the permanent features of tax law in effect during 2017. They exclude provisions that were scheduled
to expire.
b. Provisions in effect in 2022 include bonus depreciation, which is scheduled to phase out by 2027.
c. The permanent provisions of the 2017 tax act apply in 2027 and beyond.
Effective Tax Rates on Capital Income Under Pre-2018 Law and
the 2017 Tax Act (Equity-Financed C Corporations Only)
Pre-2018 Law a Provisions of
the 2017 Tax
Act in Effect
in 2022 b
Permanent
Provisions of
the 2017 Tax
Actc
All Intangible Assets 11 12 15
Purchased software 41 22 28
Research and development -14 11 11
Entertainment, literary, and artistic originals 38 13 27
Mineral exploration and development 11 10 10
Brand identity arising from advertising 8 8 8
All Tangible Assets 35 21 24

13. 12
CBO
Capturing the Tax Effects of
Multiyear Development Periods
and the Risk of Failure

14. 13
CBO
Although effective tax rates are a reliable measure of
the tax burden associated with different statutory tax
rates and methods of cost recovery, they do not
adequately capture the effect of multiyear
development periods or the risk of failure.
Those phenomena require an investor to consider
rates of return in three different states in order to
decide whether to invest.

15. 14
CBO
 The development state, in which the investment temporarily generates no
return, although its success is still anticipated
 The failure state, in which the investment does not generate any return and
success is no longer anticipated
 The success state, in which an investment must generate an above-market
return to offset the lack of returns in the development and potential failure
states
Three States Investors Must Consider in the Presence of
Multiyear Development Periods and Failure Risks

16. 15
CBO
This table illustrates only the effects of risk. Development-period effects are more complicated, but tax wedges are still a more reliable indicator
of their effect on the tax burden than are effective tax rates.
Standard State
(No risk)
Success State
(50 percent risk of failure)
Before-Tax Rate of Return 6 percent 12 percent
After-Tax Rate of Return 4 percent 8 percent
Tax Wedge (Before-tax rate of
return minus after-tax rate of
return) 2 percentage points 4 percentage points
Effective Tax Rate (Tax wedge
divided by after-tax rate of
return) 33 percent 33 percent
Calculations of the Tax Burden in the Standard State and the
Success State

17. 16
CBO
 Oil exploration and well development by integrated companies
– 6-year development period
– 10 percent failure rate
 New drug research and development
– 12-year development period
– 90 percent failure rate
 Motion picture development and production
– 3-year development period
– 50 percent failure rate
Three Types of Investments Used to Illustrate the Tax Effects
of Multiyear Development Periods and Failure Risks

18. 17
CBO
Rates of Return and Tax Wedges for Three Types of Intangible
Assets Under Pre-2018 Law
Oil Well
Development
New Drug
Research and
Development
Motion Picture
Development
and Production
Success-State After-Tax Rate of Return
Standard after-tax rate of return (Percent) 4.8 4.8 4.8
Development-period wedge (Percentage points) 0.6 1.4 0.2
Risk wedge (Percentage points) 0.6 55.6 5.0
Total (Percent) 6.0 61.8 10.0
Success-State Tax Wedge
Standard tax wedge (Percentage points) 0.7 -0.9 3.1
Development period’s contribution (Percentage
points) 0.1 0.1 0.1
Failure risk’s contribution (Percentage points) 0.1 1.2 1.5
Total (Percentage points) 0.9 0.4 4.7

19. 18
CBO
a. CBO’s computations account for only the permanent features of tax law in effect during 2017. They exclude provisions that were scheduled
to expire.
b. Provisions in effect in 2022 include bonus depreciation, which is scheduled to phase out by 2027.
c. The permanent provisions of the 2017 tax act apply in 2027 and beyond.
Tax Wedges for Three Types of Intangible Assets Under Pre-2018
Law and the 2017 Tax Act
Pre-2018 Law a Provisions of
the 2017 Tax
Act in Effect
in 2022 b
Permanent
Provisions of
the 2017 Tax
Act c
Standard Tax Wedge
Oil Well Development 0.7 0.6 0.6
New Drug Research and Development -0.9 * 0.1
Motion Picture Development and Production 3.1 0.4 1.9
Success-State Tax Wedge
Oil Well Development 0.9 0.7 0.8
New Drug Research and Development 0.4 5.0 5.1
Motion Picture Development and Production 4.7 0.9 3.0

20. 19
CBO
 The tax burden on investment in intangible assets is generally lower than the
tax burden on investment in tangible assets.
 The 2017 tax act increases the tax burden on research and development
beginning in 2022, but it reduces the tax burden on most other types of
intangible assets.
 The success-state tax wedge is a more reliable measure of the tax burden than
either the standard tax wedge or the effective tax rate because it accounts for
multiyear development periods and the risk of failure.
 Using the success-state tax wedge illuminates the additional tax burden placed
on research and development by the 2017 tax act.
Summary of Results