Tax Reform Act Of 1986 Research Articles

Summaries of Papers In This Issue

Summaries of Papers In This Issue

Market and Firm Reaction to Targeted Tax Benefits: Evidence from the Tax Reform Act of 1986

ABSTRACTA growing body of work examines market and firm responses to specific tax benefits. We extend this literature by examining market and firm reactions to an economically significant targeted tax refund granted to a few large, but poorly performing, steel firms by the Tax Reform Act of 1986 (TRA86). We find, relative to steel firms not receiving the refund, qualifying firms experience either a negative or insignificant market reaction around each of three key dates in the TRA86 legislative process. Using difference-in-differences analyses to test a variety of refund uses, we find that refund recipients use the proceeds to pay down debt rather than to increase capital assets, payouts to shareholders, acquisitions, or employment. Overall, we find targeted tax benefits granted to significant but struggling firms, while potentially politically appealing, appear to generate limited economic benefits to those targeted firms.Data Availability: Data used in this study are available from public sources identified in the text.JEL Classifications: H25.

Inequality-growth nexus under progressive income taxation

Within heterogeneous-household extensions of Romer’s (1986) one-sector representative agent model of endogenous growth, this paper finds that changes made to the U.S. statutory income tax in the past decades account for a substantial portion of the following stylized facts: (i) U.S. income inequality significantly deteriorates since the mid-1980s; (ii) the inequality-growth nexus displays a positive slope before and after the implementation of the Tax Reform Act of 1986 (TRA-86); and (iii) the slope of the inequality-growth nexus sharply declines between the pre- and post-TRA-86-reform periods, indicating less deterioration in real GDP per capita growth when pursuing a more equal income distribution after 1986. In addition to income inequality, the responses of several other measurements of inequality to changes in the tax code parameters are also explored.

Analysts’ earnings forecasting behavior surrounding uncertain regulatory events: evidence from the Tax Reform Act of 1986

This study examines analysts’ forecasting behaviour in the presence of significant tax policy uncertainty. The Tax Reform Act of 1986 (TRA86) was preceded by a lengthy debate, allowing us to investigate how tax policy uncertainty evolves over time. Our results are generally consistent with the intuition that uncertainty precedes the enactment of a proposed tax law while complexity manifests afterwards. Using the repeal of the investment tax credit to identify highly impacted firms, we find that the onset of disagreement among analysts during the debate occurred sooner for highly impacted firms than other firms. We also find that disagreement among analysts was concentrated among highly impacted firms before and after enactment. Given that our sample period precedes Regulation Fair Disclosure, our evidence suggests that analysts relied on private information from management to resolve the uncertainty associated with TRA86 but only for highly impacted firms.

TAX POLICY AND ORGANIZATIONAL FORM

We provide historical context to assess the implications of the Tax Cuts and Jobs Act of 2017 (TCJA) on organizational form. We review the Tax Reform Act of 1986 (TRA86) to assess the extent of organizational form changes in response to changing tax incentives and the effects of those organizational form changes on business operations. We develop a simple analytic model to provide insight into the incentives created by the TCJA and briefly summarize practitioner observations regarding the incentives affecting organizational form decisions. Results suggest that an array of factors make the organizational form decision more difficult and less predictable than in 1986.

Market and Firm Reaction to Targeted Tax Benefits: Evidence From the Tax Reform Act of 1986

A growing body of work examines market and firm responses to specific tax benefits. We extend this literature by examining market and firm reactions to an economically significant targeted tax refund granted to a few large, but poorly performing, steel firms by the Tax Reform Act of 1986 (TRA86). We find, relative to steel firms not receiving the refund, qualifying firms experience either a negative or no significant market reaction around each of three key dates in the TRA86 legislative process. Using difference-in-differences analyses to test a variety of refund uses, we find that refund recipients use the proceeds to pay down debt rather than to increase capital assets, payouts to shareholders, acquisitions, or employment. Overall, we find targeted tax benefits granted to significant but struggling firms, while potentially politically appealing, appear to generate limited economic benefits.

Tax Policy and Organizational Form: Assessing the Effects of the Tax Cuts and Jobs Act

We provide historical context to assess the implications of the Tax Cuts and Jobs Act of 2017 (TCJA) on organizational form. We review the Tax Reform Act of 1986 (TRA86) to assess the extent of organizational form changes in response to changing tax incentives and the effects of those organizational form changes on business operations. We develop a simple analytic model to provide insight into the incentives created by the TCJA and briefly summarize practitioner observations regarding the incentives affecting organizational form decisions. Results suggest that an array of factors make the organizational form decision more difficult and less predictable than in 1986.

Tax Reform and Tax Experts

ABSTRACT The Tax Cuts and Jobs Act (TCJA), passed in 2017, represents the most comprehensive revision of the U.S. income tax since the Tax Reform Act of 1986 (TRA86). Although the TCJA shares many features with TRA86—corporate tax rate cuts, increasing the standard deduction, cutting back on deductions—it sharply differs in that it is neither revenue neutral nor distributionally neutral, both aspects of which are troubling in light of the large long-run federal fiscal imbalance and rising income inequality. Regardless of one's normative evaluation, the TCJA provides scores of natural experiments that can inform us about the consequences of tax changes on a wide range of economic behaviors.

What a Difference Thirty Years Make: A Comparison of the Tax Reforms of 1986, 2014 and 2017

This paper compares the Tax Cuts and Jobs Act of 2017, as passed by the House (TRA17H) and under consideration by the Senate (TRA17S) with two major previous efforts at comprehensive tax reform: The Tax Reform Act of 1986 (TRA86) and the draft tax reform proposed by former Ways and Means Chair David Camp (R-MI) (TRA14). It shows that TRA14 was quite similar to TRA86, but that TRA17 is very different than both. Congress should abandon TRA17 and go back to considering TRA14 on a bipartisan basis.

Do Piketty and Saez Misstate Income Inequality? Critiquing the Critiques

ABSTRACTA large body of literature points to sharply growing income inequality over the past half century. The Piketty and Saez dataset that measures income distribution provides empirical support for this claim. Our article evaluates three prominent criticisms of this dataset as well as the responses of Piketty and Saez to these criticisms. One key argument against using their dataset is that Piketty and Saez do not control for income shifting by top income earners in response to the Tax Reform Act of 1986 (TRA86) and thus overstate income inequality. In evaluating this criticism we find that a segment of their dataset likely understates income inequality; this is just the opposite of what critics assert. This implies that the Piketty–Saez dataset is a valuable resource for income inequality research and that scholars can use it to build more refined, accurate and insightful measures of income inequality.

Options for Corporate Tax Reform in 2017

Options for Corporate Tax Reform in 2017 Martin Feldstein The following was adapted from remarks originally given at the Fall 2017 meeting of the Brookings Panel on Economic Activity on September 8, 2017. The U.S. corporate tax system is wrought with problems that have accumulated over many decades. The Tax Reform Act of 1986 (TRA86) provided a major overhaul of the personal income tax, reducing the top rate from 50 percent to 28 percent while maintaining revenue and distributional neutrality. But it did little to improve the corporate tax system. Indeed, TRA86 actually raised corporate tax revenue in order to pay for reductions in personal rates. Moreover, the specific changes in depreciation rules brought about by TRA86 reduced investment incentives, biasing the tax system in favor of owner-occupied housing instead of productivity-enhancing investment in business structures and equipment. The House Republican plan, which was developed while Paul Ryan was chairman of the Ways and Means Committee, proposes to do five important things: (i) reduce the overall corporate tax rate; (ii) correct the tax treatment of the profits earned by the foreign subsidiaries of U.S. corporations; (iii) replace the traditional corporate tax with some form of cash-flow corporate tax; (iv) deal with pass-through businesses in an efficient and equitable way; and (v) avoid increasing the fiscal deficit while doing these things.1 I briefly comment on each of these five goals below. [End Page 401] I. Reducing the Corporate Tax Rate The U.S. federal corporate tax rate is presently at 35 percent, the highest among all the major industrialized countries. In addition, individual U.S. states levy corporate taxes at an average rate of 9 percent. Because state taxes are deductible when calculating federal taxable income, the overall corporate tax rate is closer to 40 percent. In contrast, the average rate among countries that belong to the Organization for Economic Cooperation and Development is about 25 percent. The effective corporate tax rate is reduced by accelerated depreciation of investment in plants and equipment and by the deduction of nominal interest payments rather than the lower real interest payments. These are similar to the practices in other industrial countries. The House Republican plan calls for reducing the statutory rate from 35 percent to 20 percent. The Trump presidential campaign called for reducing it to 15 percent. Reducing the corporate tax rate would attract funds to the corporate sector from other uses, such as owner-occupied housing and agriculture. It would also attract foreign capital to the U.S. corporate sector. These shifts would increase the efficiency with which capital is allocated across sectors and across international markets. The increased capital in the U.S. business sector would raise the productivity and real wages of American workers. It would also increase real GDP growth as the corporate capital stock grows. Although lowering the corporate tax rate would have substantial economic benefits, it would also have a significant budgetary cost. Because the corporate income tax presently accounts for about 1.6 percent of GDP, cutting the rate from 35 percent to about half that level would directly reduce revenue by about 0.8 percent of GDP. Though this would be partly offset by the faster economic growth and by the rise in real wages and profits, there would still be an increase in the budget deficit. To limit the revenue loss and achieve a long-run balanced budget, the statutory rate will probably need to be reduced to no less than 25 percent, a point to which I return below. II. Correcting the Tax Treatment of the Profits Earned by the Foreign Subsidiaries of U.S. Corporations The United States is virtually alone in how it taxes the profits earned by the foreign subsidiaries of domestically based corporations. Consider a foreign subsidiary of a U.S. corporation that earns profits in Ireland. It pays [End Page 402] the Irish government a 12 percent tax and is then free to do what it wants with the after-tax profits. It can invest them in Ireland, or hold them in financial assets, or invest them in any other country in the world. But if it brings these after-tax...

EVALUATING PENSION PORTABILITY REFORMS: THE TAX REFORM ACT OF 1986 AS A NATURAL EXPERIMENT ABSTRACT

This article exploits a change in the vesting rules for employer‐sponsored pension plans introduced by the Tax Reform Act of 1986 to identify the causal effect of pension portability legislation on workers' voluntary mobility decisions. We pool data from different years of the Survey of Income and Program Participation to estimate the impact of this reform using difference‐in‐differences methods. Our results suggest that the reform had a positive and significant impact on voluntary job mobility of the treatment group. (JEL J24, J44, J62, J63, J68)

CHANGES IN THE ORGANIZATION OF BUSINESS ACTIVITY AND IMPLICATIONS FOR TAX REFORM

We review the changing economic significance of various business entity types since the Tax Reform Act of 1986 (TRA86) and the implications of these changes for the design of tax policy. In particular, we focus on the increased role of pass-through entities and the declining significance of the taxable corporate form. Our analysis suggests that significant reductions in the corporate tax rate, absent changes in the personal tax rate, will likely reverse the organizational form incentives that have existed since TRA86. Further, if the loss in revenue from a rate reduction is offset by a broadening of the tax base, most business entities, comprising most business income, are likely to face an overall increase in their tax burden.

The Extent of Implicit Taxes at the Corporate Level and the Effect of TRA86*

We examine the extent of implicit taxes at the corporate level and the effect on implicit taxes of the Tax Reform Act of 1986 (TRA86) in the United States. Using a variety of specifications, we find consistent evidence that implicit taxes eliminate virtually all of the cross-sectional differences in explicit tax preferences prior to TRA86, and then abruptly decline and eliminate only about one-third of the crosssectional differences in tax preferences in years following TRA86. We triangulate this evidence that implicit taxes declined following TRA86 by also providing evidence (a) of a decline in the relation between changes in tax preferences and changes in pre-tax returns, (b) of an increase in the persistence of tax-related earnings changes, (c) that these dramatic economic changes are priced by investors. Finally, we provide evidence suggesting that the decline in implicit taxes after TRA86 is driven at least in part by expansion of aggressive tax planning and use of tax shelters. Taken together these results indicate that TRA86 had a profound and lasting effect on implicit taxes at the corporate level. JEL classification : M41, H25

Looking Under the Lamp-Post: Using the Piketty-Saez Data Set to Understand Income Inequality and Income Shifting

From at least 1960-1986 the PikettySaez (P-S) data set understates the concentration of income among top income earners. Adjusting the P-S data series for income shifting in response to changes in income taxation for top earners shifts income shares upward for the years prior to the Tax Reform Act of 1986 (TRA86). We calculate that adjusted income share of the top one percent of earners are overstated by over two percentage points for many of the years that the P-S series reports historically low income inequality. Our adjustment reflects just one aspect of major tax regime change during the past century, namely the relationship between the top marginal personal income tax rate and the corporate income tax rate. It is likely that adjustments for other changes in income tax law would lead to even greater increases in income shares during the high-marginal rate era between World War II and the mid-1980s.

Equity: The Effects Of Tax Reform On Progressivity Features Of The Tax Structure

The impact of the Tax Reform Act of 1986 (TRA86) on equity is examined using a simulation program and statistical analysis. Specifically, a sample of tax returns was manipulated to calculate taxable income for 1987 and 1988. The results were then compared to determine the degree to which effective and average tax rates changed within discrete income levels. Using both t-test and z statistics, the results confirm the hypothesis that the degree of progressivity has been affected by TRA86. A graphic analysis illustrates this change at various income levels for both the average and effective tax rates. These findings are significant for tax policy decision purposes.

Tax Reform And Bank Asset Quality: Did 1986 Tax Law Changes Contribute To Banks Loan Problems?

The escalation of bank loan losses in the mid/late 1980s, attended by a marked decrease in banking industry profits and an increase in bank failures, has raised numerous questions about the factor contributing to these events. The present study continues this inquiry by examining the effects of the Tax Reform Act of 1986 (TRA86) on the quality of banks assets in the late 1980s. Specifically, the study seeks to attribute changes in bank asset quality following enactment of TRA86 to 1) the two major provisions of the law targeted at banks, namely, interest expense allocable to tax-exempt obligations and the tax reserve for bad debts, particularly bad debts of large banks, along with 2) the pre-TRA86 level of real estate loans that were devalued by other provisions of the statute. Using alternative measures of asset quality, a single-equation regression analysis was applied to a sample of 205 large commercial banks. Empirical results indicate some linkage between TRA86 and changes in bank asset quality during the late 1980s, though not in all areas examined.

Tax Reform and Automatic Stabilization

A fundamental property of a progressive income tax is that it provides implicit insurance against shocks to income by dampening the variability of disposable income and consumption. The Economic Recovery Tax Act of 1981 (ERTA) in combination with the Tax Reform Act of 1986 (TRA86) greatly reduced the number of marginal tax brackets and the maximum marginal rate, which limits the stabilizing effect of the tax system on household consumption when pre-tax income fluctuates. We examine the effect of the federal income tax reforms of the 1980s on the associated degree of automatic stabilization of consumption. The empirical framework derives from the consumption insurance literature, where the ideal outcome is spatially equal changes in households’ marginal utilities of consumption, and permits partial insurance, which we use to identify how the degree of consumption insurance has changed since ERTA and TRA86. Our data come from interview years 1980–1991 in the anel Study of Income Dynamics. We find that in certain cases the tax reforms of the 1980s actually increased the automatic stabilization inherent in the United States income tax. Overall, ERTA and TRA86 reduced consumption stability by about 50 percent. More recent tax reforms, most notably increased EITC generosity, have restored or enhanced consumption insurance. A welfare analysis indicates that the cost of moving to the post-TRA86 system is sizable for relatively risk averse households facing large income risk, but is much more modest for the typical household.

TAXES, HEALTH INSURANCE, AND WOMEN'S SELF‐EMPLOYMENT

I examine whether the availability of health coverage through the spouse's health plan influences a married woman's decision to become self‐employed. The Tax Reform Act of 1986 (TRA86) introduced a tax subsidy for the self‐employed to purchase their own health insurance. I test whether this “natural” experiment induced more women without spousal health insurance coverage to select into self‐employment. The most conservative difference‐in‐difference estimates based on an analysis of employed women indicate that the incidence of self‐employment among single women rose by 10% in the post‐TRA86 period, while a multinomial specification based on a sample of both employed and nonemployed women suggests that the increase was about 13%.(JELJ0, J3, I1)

The Extent of Implicit Taxes at the Corporate Level and the Effect of TRA86

We examine the extent of implicit taxes at the corporate level and the effect on implicit taxes of the Tax Reform Act of 1986 (TRA86). Using a variety of specifications, we find consistent evidence that implicit taxes eliminate virtually all of the cross-sectional differences in explicit tax preferences prior to TRA86, and then abruptly decline and eliminate only about one-third of the cross-sectional differences in tax preferences in years following TRA86. We triangulate this evidence that implicit taxes declined following TRA86 by also providing evidence (a) of a decline in the relation between changes in tax preferences and changes in pre-tax returns, (b) of an increase in the persistence of tax-related earnings changes, (c) that these dramatic economic changes are priced by investors. Finally, we provide evidence suggesting that the decline in implicit taxes after TRA86 is driven at least in part by expansion of aggressive tax planning and use of tax shelters. Taken together these results indicate that TRA86 had a profound and lasting effect on implicit taxes at the corporate level.