Empirical Evidence of Implicit Taxes in the Corporate Sector.

The Federal government has enacted special tax provisions that are estimated to cost the Treasury more than $200 billion each year. The purpose for many of these tax incentives is to induce firms to after their investment, production, and financing decisions away from the pre-tax optimum established by the private market, and toward an equilibrium that the government deems to yield greater social welfare. This induced reallocation of resources away from the pre-tax optimum is hypothesized to cause firms to suffer reductions in pre-tax return that are referred to as implicit taxes. Thus, in order to achieve a more desirable equilibrium, the Federal government provides firms with opportunities to reduce explicit taxes (increase tax subsidies), and competition among firms for the right to reduce their explicit taxes results in anticipated increases in implicit taxes (reductions in pre-tax return). This paper provides empirical evidence on the cross-firm and through-time relations between pre-tax return and tax subsidy for 818 firms during the 1968-85 period. The results are consistent with the predictions of the implicit tax hypothesis, showing a consistent and statistically significant inverse relation between pre-tax return and tax subsidy. However, the empirical relation is weaker than predicted for a perfectly competitive and frictionless economy, which suggests the presence of nontrivial market frictions or systematic measurement error.