Corporate Taxation and the Efficiency Gains of the 1986 Tax Reform Act
Jane G. Gravelle
Laurence J. Kotlikoff
The 1986 Tax Reform Act, while having little effect on the overall
effective tax rate on U.S. capital income, did reduce significantly the
difference in effective taxation of corporate and noncorporate capital within
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. Unlike the Harberger
Model, the Mutual Production Model permits both corporate and noncorporate
firms to produce the same goods and, therefore, to coexist within a given
This paper develops an 11 industry - 55 year dynamic life cycle version
of the Mutual Production Model. We use this model to study the steady state
efficiency gains associated with the new law. While we do not simulate the
economy's transition path, our steady state welfare changes are those that
arise from compensating transitional generations for the first order
redistribution of income associated with the Tax Reform.
We find that the 1986 Tax Reform law reduces excess burden by .85 percent
of our model's economy's present value of consumption. This efficiency gain
reflects the Tax Reform's reduction in corporate non-corporate tax wedges,
particularly in those industries with significant non-corporate production.
Measured as a flow the 1988 estimated efficiency gain from the Tax Reform Act
is $31 billion.
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