Understanding Investment Incentives Under Parallel Tax Systems: An Application to the Alternative Minimum Tax

The first section of this paper introduces the topic. The next section shows that many parallel tax systems share common features and constructs a general model of the cost of capital based on the Hall-Jorgenson (1967) cost of capital formula. Section 3 presents conditions under which a parallel tax system maintains investment neutrality. In general, the neutrality conditions are sensitive to the assumed arbitrage conditions and source of finance. Section 4 presents findings on the effect of the corporate ANT on investment incentives. It is shown that these investment incentives are sensitive to the length of time the firm is subject to the ANT, the timing of the Mt spell relative to the date the investment is acquired, and the source of financing. Investment incentives for firms experiencing temporary spells on the ANT can be very different from those for firms permanently subject to the ANT. The final section briefly summarizes the paper

The Effect Of The Investment Tax Credit On The Value Of The Firm

A change in the tax law that increases investment incentives for new assets may result in excess returns on new investment, causing firm value to increase. Alternatively, because the investment incentives apply only to new investments, the value of existing assets that compete with these investments may decline. A model is developed in this paper which shows that in general investment incentives have a theoretically ambiguous effect on firm value. Models proposed by Abel (1982), Auerbach and Kotlikoff (1983), and Feldstein (1981) are shown to be special cases of this more general model. Empirical tests examine the changes in firm value to repeated changes of the investment tax credit. Cross-sectional teats find the changes in firm value are positively related to the expected receipt of investment tax credits. No evidence is found to support a relationship between expected changes in the value of a firm's existing assets and changes in firm value.

Non-Leaky Buckets: Optimal Redistributive Taxation and Agency Costs

Economists have generally argued that income redistribution comes at a cost in aggregate incomes. We provide a counter-example in a model where private information gives rise to incentive constraints. In the model, a wage tax creates the usual distortion in labor-leisure choices, but the grants that it finances reduce a distortion in investment in human capital. We prove that simple redistributive policies can yield Pareto improvements and increase aggregate incomes. Where higher education is beyond the reach of the poor, the wage tax- transfer policy is under most circumstances more effective than targeted credit taxes or subsidies in increasing over-all efficiency.

The Alternative Minimum Tax and the Behavior of Multinational Corporations

This paper examines the extent to which U.S.-based multinational corporations are affected by the alternative minimum tax. More than half of all foreign-source income received by corporations in 1990 was earned by corporations subject to the alternative minimum tax. The AMT rules potentially affect multinational corporations in a manner different from their effect on domestic corporations. The paper examines the differential incentives the AMT creates for locating investment either domestically or abroad and considers how the incentives for the repatriation of foreign-source income are affected by the AMT. Tax return data of U.S.-based multinationals are examined to see the extent to which these incentives may influence the repatriation of foreign-source income.

Progressivity of Capital Gains Taxation with Optimal Portfolio Selection

We provide new data on capital gains realizations using a five-year stratified panel of taxpayers covering 1985-1989. We find, as earlier studies have, that capital gains realizations are very concentrated among the highest income groups. We use these data and data from the Federal Reserve Board Survey of Consumer Finances to draw inferences from a simulation model of the effects on progressivity and efficiency of alternative tax treatment of capital gains. Tax payments alone are not an accurate indication of the burden of a tax. Taxes generally create costs beyond the dollar value collected by causing persons to change their behavior to avoid the tax. Risk is also affected by the tax system. Beneficial risk-sharing characteristics of the tax system are frequently overlooked when examining the treatment of capital gains, We find that reforms comprising reductions in the capital gains tax rate offset by increases in the tax rate on other investment income are efficiency reducing. Surprisingly, we find that for taxpayers for whom loss limits are not binding a switch to accrual taxation is also efficiency reducing. For those taxpayers for whom loss limits are potentially binding, we find that large efficiency gains can be achieved by increasing the amount of capital losses that may be deducted against ordinary income. These results are partly attributable to changes in risk-sharing encompassed in these reforms.

Does the Tax System Favor Investment in High-Tech or Smoke-Stack Industries?

When tax rates vary by asset, a "hidden" industrial policy may aid industries that invest in a certain mix of assets. In this paper, we examine whether differential use of depreciable assets gives rise to differential tax treatment of high technology industries relative to other industries. First, we calculate the total effective tax rate on a marginal investment in each of 34 assets. Next, using these asset-specific tax rates and weighting by the use of these assets in each of 73 different industries, we calculate total effective tax rates at the industry level. We find considerable variation within the high-tech sector and within the more traditional sector, but for the case of a taxable firm with a given debt/equity ratio, we do not find any systematic differences between overall rates in the two sectors.

Uncertain Parameter Values and the Choice Among Policy Options

In this paper, we use tax policy choices to illustrate and investigate the more general problem of using uncertain parameter values in models to evaluate policy choices. We show, for this tax example, how debate on an elasticity parameter translates into a debate about policy choices, andvice versa. To construct this example, we suppose that the choice among four particular tax reform options is based on a single measure of efficiency gain. We show how this gain from each reform depends upon the elasticity of saving with respect to the net rate of return. Within quite narrow and reasonable bounds for the elasticity parameter, we find regions in which each of three different tax reforms turns out to dominate the others.

Tax Neutrality and Intangible Capital

Many studies measure capital stocks and effective tax rates for different industries, but they consider only tangible assets such as equipment, structures, inventories, and land. Some of these studies also have estimated that the welfare cost of tax differences among these assets under prior law is about 10 billion per year or 13 percent of all corporate income tax revenue. Since the investment tax credit was available only for equipment, its repeal raises the effective rate of taxation of equipment toward that of other assets and virtually eliminates this welfare cost. However, firms also own intangible assets such as trademarks, copyrights, patents, a good reputation, or general production expertise. This paper provides alternative measures of the intangible capital stock, and it investigates implications for distortions caused by taxes. The existence of intangible capital markedly alters welfare cost calculations. Investments in advertising and R&D are expensed, so the effective rate of tax on these assets is less than that on equipment under prior law. With large differences between these assets and other tangible assets, we find that the welfare cost measure under prior law increases to 13 billion per year. Repeal of the investment credit taxes equipment more like other tangible assets but less like intangible assets. The welfare cost still falls, to about $7 billion per year, but it is no longer "virtually eliminated." With additional sources of intangible capital, credit repeal could actually increase welfare costs. Finally, however, the Tax Reform Act of 1986 not only repeals the investment tax credit but reduces rates as well. Efficiency always increases in this model because the taxation of tangible assets is reduced toward that of intangible assets.