Differential Taxation of Capital Income: Another Look at the 1986 Tax Reform Act

The Tax Reform Act of 1986 considerably altered the differentials between taxes on corporate and noncorporate capital. A new model which allows corporate and noncorporate firms to coexist within an industry suggests significant efficiency gains from these changes, reducing excess burden by $15 billion, or .43 percent of consumption. This gain is over five times the size of that which would be predicted by the Harberger model and occurs because the Act, while keeping the overall tax rate constant, considerably narrowed the differentials between corporate and noncorporate firms in most industries where there is substantial noncorporate production.