CORPORATE TAX EQUITY AND THE TAX REFORM ACT OF 1986: AN EXAMINATION OF THE RELATIONSHIP BETWEEN EFFECTIVE TAX RATES AND INVESTMENT RISK.

摘要

The corporate provisions of the Tax Reform Act of 1986 (TRA86) were designed to ensure that corporations pay taxes in proportion to their abilities to pay tax (House 1985, 55; Senate 1985, 6) and to equalize the tax burdens of diverse economic activities (House 1985, 58-9; Senate 1985, 7). Prior research used financial statement data to examine the distribution of corporate average effective tax rates and reached inconsistent conclusions regarding the effects of TRA86 on the equality of corporate tax burdens.; A limitation of the prior studies is that average effective tax rates were computed with measures of ability to pay tax did not explicitly account for differences in the risk associated with corporate investment. Corporations with higher levels of risk (higher risk premia) generally have higher costs of investment capital and, therefore, lesser abilities to pay tax. If average effective tax rates vary across income levels (the corporate tax is non-proportional), tax burdens are not equalized across risk levels, because the tax differentially affects corporate risk premia. If average effective tax rates are constant across income levels (the corporate tax is proportional), tax burdens are equalized across risk levels, because the changes to risk premia are proportional.; This study examined the effects of TRA86 on the relationship between average effective tax rates and investment risk (beta). Vertical equity, the equality of tax burdens between corporations with different levels of risk, was defined as the constancy of average effective tax rates at different levels of risk. Horizontal equity, the equality of tax burdens between corporations with equal levels of risk, was defined as the variability of average effective tax rates between corporations with equal levels of risk. Two null hypotheses were tested. The first hypothesis was that there was no systematic change in vertical equity as a result of TRA86. The second hypothesis was that there was no systematic change in horizontal equity as a result of TRA86.; The results showed that average effective tax rates were constant across investment risk levels both prior to and following TRA86, and that TRA86 did not systematically alter this relationship, suggesting vertical equity. The variability of average effective tax rates for corporations with equal levels of investment risk increased significantly following TRA86. This result suggests that TRA86 resulted in lower horizontal equity, because it may cause the risk premia of corporations to increase based not on the true risk of investment, but due to a higher tax burden.; The findings are important because they suggest that the pre-TRA86 tax system may have been more equitable than perceived. The failure to explicitly account for differences in investment risk may have contributed to perceived inequities in the pre-TRA86 taxation of corporations and resulted in unnecessary tax reform.