CORPORATE-TAXATION AND THE EFFICIENCY GAINS OF THE 1986 TAX-REFORM ACT

The 1986 Tax Reform Act (TRA) had little effect on the overall U.S. ef fective capital income tax rate. However, TRA significantly reduced di fferences in effective taxation of corporate and noncorporate capital for a number of U.S. industries. The Mutual Production Model developed in Gravelle and Kotlikoff (1989) can be used to study the efficiency gains from the reduction in corporate tax wedges within industries. Un like the Harberger Model, the Mutual Production Model permits both cor porate and noncorporate firms to produce the same goods and, therefore , to coexist within a given industry. This paper develops an 11-indust ry-55-year dynamic life cycle version of the Mutual Production Model. We use this model to study the steady-state efficiency gains associate d with the new law. While we do not simulate the economy's transition path, our steady-state welfare changes are those that arise from compe nsating transitional generations for the first-order redistribution of income associated with the Tax Reform. We find that the 1986 Tax Refo rm law reduces excess burden by .85 percent of our model's economy's p resent value of consumption. This efficiency gain reflects the Tax Ref orm's reduction in corporate-noncorporate tax wedges, particularly in those industries with significant noncorporate production. Measured as a flow the 1988 estimated efficiency gain from the Tax Reform Act is $31 billion.