Tax Law Changes Research Articles

Extent of Taxable Losses - an Empirical Analysis of Their Effect on Revenues and Distribution (Ausmaß der steuerlichen Verlustverrechnung - Eine empirische Analyse der Aufkommens- und Verteilungswirkungen)

The paper examines the extent and structure of taxable losses, their effect on revenues and distribution by means of microanalysis and microsimulation. The examination is based on the income and corporation tax statistics of the German Federal Statistical Office for the period from 1989 to 2001. Moreover, it is tried to establish a connection between the observable developments and the changes in tax law. The results of this analysis illustrate the importance of the losses for the tax revenue. Because of the substantial losses generated in the nineties and the current fiscal situation of the public households an extension of loss offset seems to be unrealistic. The results reveal also aspects of distribution which where hardly considered in the past discussion.

Enhancing stock returns using hedged dividend capture

Purpose – This paper aims to explore the potential use of a dividend capture strategy by individual investors. This strategy arises from the 2003 tax law changes which lowered tax rates on dividends received, while leaving the short‐term tax rates on capital losses unchanged. In addition, leverage can be used in combination with an aggressive call‐writing strategy to receive a multiple of the tax‐advantaged dividend yield without a corresponding increase in risk.Design/methodology/approach – In addition to illustrating how the dividend capture strategy works, a new method of comparing returns between strategies is developed. This method does not rely on a particular risk‐return model, such as is used by the Sharpe ratio or Jensen's alpha methodologies. Finally, a formula is derived which computes the borrowing (margin loan) rate that makes the aggressive call‐writing strategy profitable.Findings – The 2003 changes in US tax laws provide individuals with an opportunity to apply dividend capture techniques ...

Tax Incentives for Inefficient Executive Pay and Reward for Luck

I study the economic consequences of tax deductibility limits on salaries for the design of incentive contracts. The analysis is based on a simple agency model in which the firm's cash flow is a function of the agent's effort and an observable random factor beyond the agent's control. According to my analysis, limiting the tax deductibility of fixed wages has two consequences. The principal rewards the agent on the basis of the observable random factor and offers him a contract with weaker work incentives than without the tax. The theoretical findings have some interesting implications for empirical compensation research. First, the analysis shows that reward for luck can be the optimal response to recent tax law changes, whereas earlier empirical literature has attributed this phenomenon to managerial entrenchment. Second, I demonstrate that a simple regression analysis that fails to control for separable measures of luck is likely to find an increased pay for performance sensitivity as a response to the introduction of tax deductibility limits on salaries although the pay for performance sensitivity has actually declined.

Tax bases, tax rates and the elasticity of reported income

Tax reforms usually change both tax rates and tax bases. Using a panel of income tax returns spanning the two major U.S. tax reforms of the 1980s and a number of smaller tax law changes, I find that the elasticity of income reported on personal income tax returns depends on the available deductions. This highlights that this key behavioral elasticity is not an immutable parameter but rather that it can be to some extent controlled by policy makers. One implication is that base broadening reduces the marginal efficiency cost of taxation. The results are very similar for all income categories indicating that the rich are more responsive to tax rates because tax rules that apply to them are different (their tax base is narrower). The point estimates indicate that the Tax Reform Act of 1986 reduced the marginal cost of collecting a dollar of tax revenue, with roughly half of this reduction due to the base broadening and the other half due to the tax rate reduction. As a by-product, the analysis in this paper offers a reconciliation of disparate estimates obtained by previous studies of the tax responsiveness of income.

State-Sponsored College 529 Plans: The Influence of Tax and Non-Tax Factors on Investors' Choice

Taxpayers have invested over $45 billion in state-sponsored 529 college savings plans. Created by federal legislation in 1996 and enhanced by a 2001 tax law change, all 50 states and the District of Columbia now offer a 529 plan. States provide tax deductions and/or exemptions to taxpayers choosing in-state plans. Because of the lack of historical return data on these funds and the absence of comparable investment vehicles, investors rely extensively upon securities dealers for fund recommendations. Using proprietary panel data for 77 plans in 50 states over eight quarters, this paper compares tax and non-tax factors that drive 529 investment choices. This paper explains why an investor may choose an out-of-state 529 plan despite losing a potential state tax deduction. This paper also has policy implications for lifetime savings accounts proposed by the Bush administration.

Assessment of the Distribution Effects of the 'Red-Green' Income Tax Policy - A Matter of Scale (Beurteilung der Verteilungswirkungen der "rot-Grünen" Einkommensteuerpolitik - Eine Frage des Maßstabs -)

With an empirical study of the results of the reduction in the income tax schedule by the German red-green government two suitable scales for an evaluation of distributional effects of tax policy are discussed: the redistribution of tax burden and the redistribution of income caused by the analysed tax reform. It is shown, which influence the choice of the assessment scale has for the interpretation of the results. It is brought out that an evaluation focussed on net distribution of income alone is problematic because the implication of such a fiscal policy is in conflict with the primary tasks of income taxation. The redistribution effects regarding tax burdens seem to be more suitable for the assessment of distributional effects of changes in tax law.

State-Sponsored College §529 Plans: An Analysis of Factors that Influence Investors' Choice

Taxpayers have invested more than $45 billion in state-sponsored §529 college savings plans. Created by federal legislation in 1996 and enhanced by a 2001 tax law change, all 50 states and the District of Columbia now offer a §529 plan. Some states provide tax deductions and/or exemptions to taxpayers choosing in-state plans. Because of the lack of historical return data on these funds and the absence of comparable investment vehicles, investors rely extensively upon securities dealers for fund recommendations. Using proprietary panel data for 77 plans in 50 states over eight quarters, this paper compares tax and nontax factors that drive §529 investment choices. This paper explains why an investor may choose an out-of-state §529 plan despite losing a potential state tax deduction. This paper also has policy implications for lifetime savings accounts proposed by the Bush administration.

Succession Planning in the Closely Held Business

Succession planning should not be viewed as an issue that arises only when the retirement of a CEO or another key executive is imminent. Departures of senior personnel occur for a variety of reasons and are often unexpected. Succession planning for a change in the executives of a closely held business presents both income tax and transfer tax issues. Recent tax law changes have reduced the tax rate on dividends and can affect the cash flow of a company. Other tax issues will affect a company, the executives who are leaving, and the new leadership. Stock options, the type of corporation setup, and other factors can create advantages or disadvantages for a company. In closely held businesses, many executives are family members. This creates additional estateplanning scenarios. With proper planning and forethought, succession planning can ensure a smooth transition.

Toward a Consumption Tax, and Beyond

Amid the academic debate about whether a tax based on consumption or income is superior, it has long been recognized that the U.S. federal tax system is in reality a hybrid of an income and consumption tax, with some elements that do not fit naturally into either system. In recent decades, tax-law changes that altered the nature of the hybrid were generally not discussed as part of a plan to establish either a pure income tax or a pure consumption tax, but as attempts to establish a “level playing field” or to improve “incentives to save.” As of 2003, the outline of an explicit plan to move toward a consumption tax is emerging. Under the original Bush administration proposals in 2003, dividends would become taxexempt if corporate tax had been paid on the earnings supporting the dividends, and a new tax-exempt Lifetime Savings Account, with no restrictions on use, would be created. The proposed expansion of tax-exempt savings accounts was not passed, although it will likely be reintroduced in some form. What did become law were two provisions to expand expensing of qualified property: (i) an increase in the fraction of equipment investment that can be immediately written off from 30 percent (which became law in 2002) to 50 percent, and (ii) an increase through 2005 of the limit on the expensing of new depreciable assets by small businesses allowed under IRC Section 179. The 2003 tax law also reduced the rate of tax on dividends and realized capital gains received by an individual shareholder to be no more than 15 percent, compared to a top rate on “ordinary” income of 35 percent. The acceleration of depreciation, the reduction of personal tax on dividends, and an expansion of tax-favored savings accounts can be seen as part of a strategy to shift the tax base from income to consumption. If the ultimate destination of this set of tax reforms is a consumption tax base, then the most glaring omission from the discussion to date concerns interest deductibility. The continuation of interest deductibility, in spite of other moves toward a consumption tax base, raises two issues. The first is that interest deductibility plus expensing for businesses, plus exemption of financial returns of individuals produces not a zero tax on capital income, as under a consumption tax, but rather a subsidy. The second is that this tax structure allows a range of tax arbitrage opportunities among individuals and across corporations and individuals. For example, even under pre-2002 tax law, when high-tax-bracket investors borrowed from those in low (or zero) tax brackets they generated an arbitrage gain equal to the difference between the tax rates. Reducing the tax rate on interest income, but not interest deductions, to zero vastly expands this opportunity. These tax arbitrage opportunities reduce tax revenue without necessarily providing * Gordon: Department of Economics, University of California–San Diego, 9500 Gilman Drive, La Jolla, CA 92093 (e-mail: rogordon@ucsd.edu); Kalambokidis: Department of Applied Economics, University of Minnesota, 217f Classroom-Office Building, 1994 Buford Avenue, St. Paul, MN 55108-6040 (e-mail: lkalambo@apec.umn.edu); Rohaly: Urban Institute, 2100 M Street N.W., Washington, DC 20037 (e-mail: JRohaly@ui.urban.org); Slemrod: Office of Tax Policy Research, University of Michigan, 701 Tappan Street, Rm. A2120, Ann Arbor, MI 48109-1234 (e-mail: jslemrod@umich.edu). 1 The Tax Reform Act of 1986, which in many ways moved the definition of taxable income closer to economic income, may be an exception (see Charles E. McLure, Jr., 1988). 2 Jonathan Weisman (2003) reported that the Bush administration was debating whether to push “a plan for stealth tax reform in ‘five easy pieces’—lower marginal income tax rates, including capital gains tax rates; eliminate taxes on dividends; accelerate the speed with which businesses can write investment expenses off their tax bills [ultimately to the point of 100 percent first-year expensing of business capital investment]; expand the Roth individual retirement account to all personal saving; and exclude export and other foreign trade income of American companies from taxation.”

Implied Volatilities and Arbitrage Opportunities in the Italian Options Market

This paper, which follows up the analyses of an earlier study published in December 1988, starts by updating the description of the regulatory framework for Italian stock options (premium contracts), with reference both to the regulations issued by the Consob (the Italian SEC) and the changes in tax law. This is followed by figures on the size of the market and its development in recent years. After describing the standards operators use to value premium contracts and quantifying the deviations from the theoretical values, we examine the techniques for forecasting share price volatilities and verify the information content of the implied volatilities of premium contracts. The last part of the paper describes an extensive simulation designed to reveal arbitrage opportunities that operators failed to exploit during the period in question, with account being taken of transaction costs.

Understanding Recent Tax Law Changes

U.S. tax law changes that took effect in 2003 have reduced the marginal income tax rate, long-term capital gains rate, and qualifying dividend income tax rate—all of which have a significant impact on private client investors in hedge funds. But tax considerations for private client investors are not only restricted to tax rates; understanding other key factors, such as the requirements to qualify for the new reduced rates, is also important. These factors can guide investors in the questions they ask (or should ask) when conducting their due diligence.

How fair? Changes in federal income taxation and the distribution of income, 1978 to 1998

In this paper, we determine how tax law and income distribution changes have separately contributed to the changes in tax progressivity over time, and also how a specific pre-tax distribution of income affects the equalizing ability of a given tax change. We use information from the Current Population Survey for years that follow immediately after significant tax law changes or after the full enactment of these changes to measure the effect of income taxes on income distribution for selected years over the period 1978 to 1998. We find that, even when account is taken of the induced effect of changes in federal income tax laws on pre-tax income, the individual income tax structure has been less successful in equalizing after-tax income since the 1980s and into the early 1990s. We also find that a given tax law's equalizing effect on the distribution of income is significantly affected by the pre-tax distribution of income. © 2005 by the Association for Public Policy Analysis and Management.

Comments and Discussion

Comments and Discussion Kevin A. Hassett and John V. Leahy Kevin A. Hassett: This paper by Mihir Desai and Austan Goolsbee examines the impact of recent corporate tax changes on investment behavior and investigates the impact of a possible capital overhang on investment. Since my fellow discussant will focus on the overhang issue, I will concentrate my remarks on the tax and investment side of the paper. To summarize my conclusions: The paper is a good, state-of-the-art econometric effort that confirms many of the findings of the recent investment literature. The regression results are competently arrived at and believable. However, the authors' policy discussion and their discussion of the impact of recent tax reforms offer conclusions that do not follow from their results. In relating their results to the impact of current policies, the authors have favored some extreme assumptions that are not supported by their empirical work, all aligned in a manner to make the tax cuts seem ineffective. A more balanced assessment of the recent impact of the tax reforms would certainly be more favorable. A Look at the Literature. The first of the recent corporate tax changes reduced the user cost of capital by allowing firms to expense a fraction of their capital purchases. This expensing has been "temporary" from the outset, although there has been significant uncertainty about whether the expensing provisions would be allowed to expire. There is little dispute that this tax change will lower the user cost of capital. In a recent paper in the National Tax Journal, my coauthors and I found that this reduction would vary by asset class, averaging about 2 to 3 percent, if the change were viewed as permanent and if the expensing fraction were the original, lower number.1 If instead the provision were expected [End Page 339] to expire, firms would have an incentive to shift investment forward. We found that this effect would reduce the current user cost by much more. The second change was to lower the tax rate on dividends and capital gains. The effect of this change on the user cost depends on the marginal source of finance. In another recent paper, my coauthor and I found that approximately half of all firms behave as if they use new share issues as their marginal source of finance,2 and approximately half behave as if they use retained earnings. Accordingly, relying on a third recent paper, in which my coauthors and I modeled the impact of dividend tax law changes,3 I find that the reduction attributable to the recent changes would be quite large under the "old view" of dividend taxation and much smaller under the "new view." However, these conclusions depend crucially on unobservables. The most important of these are the marginal tax rates on dividends and on capital gains, which in turn depend on the nature of financial equilibrium. If, for example, a "Miller equilibrium" describes the world, the relevant rates are those at which the marginal investor is just indifferent between debt and equity, not the average observed rate. Across a range of assumptions, however, the dividend change reduces the cost of capital by about 7 percent on average, assuming that firms themselves are split 50-50 between the old and the new views. More recent evidence consistent with the idea that there exist both old and new view firms includes work by James Poterba,4 who has found that dividend payout responds significantly to tax changes, and by Raj Chetty and Emmanuel Saez,5 who found that dividend payouts increased sharply after the recent change in the law. In a work in progress, Alan Auerbach and I are exploring share price responses to the dividend change and finding results that confirm the conclusions in our earlier paper. There thus appears to be a great deal of heterogeneity in the data, with some firms behaving according to the old view and some according to the new view. Whether these changes would result in a stimulus to investment depends on the elasticity of investment with respect to the user cost. Glenn Hubbard and I, in our chapter in the Handbook of Public Economics, concluded that the literature...

Germany's Repeal of the Corporate Capital Gains Tax: The Equity Market Response

In late 1999, the German government made a surprise announcement that it would repeal the large and long-standing capital gains tax on sales of corporate crossholdings effective in 2002. The repeal has been hailed as a revolutionary step toward breaking up the extensive web of crossholdings among German companies. The lock-in effect from the large corporate capital gains tax was said to act as a barrier to efficient acquisition and divestiture of German firms and divisions. Many observers predicted that once the lock-in effect was removed, Germany would experience a flurry of acquisition and divestiture activity. Several other industrialized countries were poised to follow suit, with similar proposals pending in France, Japan, and the United Kingdom. This paper provides evidence of the economic impact of the repeal by examining its effect on the market values of German firms. While event studies of tax legislation can be difficult, our study is aided by the fact that the repeal was both a surprise and was announced separately from other tax reform proposals. In addition, we provide cross-sectional evidence on the economic magnitude of the repeal, assess the likely beneficiaries from the repeal, and predict which sectors are most likely to experience a surge in acquisition and divestiture activity following the repeal. Our results suggest that the economic effects are highly concentrated. We find a positive association between firms' event period abnormal returns and the extent of their crossholdings, consistent with taxes acting as a barrier to efficient allocation of ownership. However, the reaction is limited to the six largest banks and insurers and their extensive minority holdings in industrial firms. These six large firms have a combined market capitalization equal to 22 percent of all 394 firms in this study. We also find evidence of a positive stock price response to the announcement for industrial companies held by these financial firms, consistent with shareholders in those firms benefiting from the likely reduction in investor-level tax burdens and expected increased efficiency following the tax law change.

The Strange History of Employer‐Sponsored Child Care: Interested Actors, Uncertainty, and the Transformation of Law in Organizational Fields

This article examines the development and diffusion of two “family‐friendly” employment benefits: dependent care expense accounts and employer‐sponsored child care centers. Using over‐time analysis of the adoption of these programs in 389 U.S. organizations, historical research, and interviews with human resources managers, this study demonstrates that organizations added dependent care expense accounts in response to changes in tax law and, in particular, to the creative interpretation by benefits consultants of a seemingly concrete and clear law. Although the tax break included in the 1981 Economic Recovery Tax Act was intended to spur employers to create child care centers, these programs are still rare. This article extends institutional theories of law and organizations by arguing that interested actors create, as well as respond to, uncertainty in the law.

A tale of two tigers: employee financial participation in Korea and Taiwan

This paper examines the structure and evolution of programmes for exmployee financial participation in South Korea and Taiwan. Reasons for the changing incidence of these programs over the post-World War II period are examined. These case studies are then placed in comparative perspective. In Taiwan, several programmes play important roles: year end bonuses in proportion to salary, profit sharing, employee ownership plans, and combination stock and profit-sharing programmes. The latter are more effective in employee retention and in reflecting genuine sharing of net income than other plans, but have been perceived as contrary to outside shareholder interests, have attracted attention in trade dumping disputes because of their non-taxed status, and function less effectively in unprofitable firms. In South Korea, ESOPs are the most prominent form of financial participation, having risen strongly in the decades prior to the 1997 financial cirsis but falling at that time, due both to the crisis and to unfavorable tax law changes. Taiwan has embraced stock options and other programmes associated with a more entrepreneurial, risk-taking culture, in common with high tech US firms. Korea's ESOP programme has more in common with those of large, established firms in the US. These differences reflect the contrast in corporate culture between the two economies, with Taiwans's economy dominated by smaller and more flexible firms, and Korea's by large conglomerates enjoying benefits of market share.

Rent Seeking by Agents of the Firm

This study examines the role of managers’ political campaign contributions in relation to their firms’ tax benefits. The study differs from extant public choice literature that has not examined the role of self‐interested agents within the firm. Using a major tax law change, we find that firms’ political action committee contributions and individual managers’ campaign contributions are both positively associated with firm tax benefits (rents) at stake. We also observe these contributions to be an increasing function of managers’ wealth effects through the existence of bonus plans that are based on after‐tax earnings and ownership of the firm’s stock. The policy implications are that firms’ own tax benefits, as well as its managers’ individual wealth‐enhancing effects, may influence campaign contributions.

November election means tax law changes

November election means tax law changes

German Government Formally Announces Proposed Tax Law Changes

German Government Formally Announces Proposed Tax Law Changes

The Impact of the 1986 Tax Reform Act on Income Shifting from Corporate to Shareholder Tax Bases: Evidence from the Motor Carrier Industry

Using a sample of privately held C corporations and S corporations from the motor carrier industry during 1984–92, we assess the effect of the 1986 Tax Reform Act on the amount of corporate income shareholders of privately held C corporations shifted to their personal tax bases. We estimate that the C corporations shifted a mean of $130,587 taxable income each year to shareholders (representing 29% of their mean accounting earnings before income shifting) after the 1986 tax law change. The C corporations used deductible managerial compensation and rent expense, but not interest expense, to shift income to shareholders.