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Tax Shelters and Passive Losses after the Tax Reform Act of 1986

In: Empirical Foundations of Household Taxation

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  • Andrew A. Samwick

Abstract

The precipitous decline in tax sheltered investments after the Tax Reform Act of 1986 (TRA) is widely attributed to the passive loss rules. These rules disallowed losses from activities in which the taxpayer did not materially participate as a current deduction against all sources of income except for other passive activities. This paper demonstrates instead that the role of the passive loss limitations was secondary to that of other reforms enacted by TRA, most importantly the repeal of the investment tax credit and the long-term capital gain exclusion. These other reforms not only lowered after-tax rates of return on tax sheltered investments but also eliminated the positive correlation between the investor's marginal tax rate and the investment's after-tax rate of return. As a result, high income taxpayers ceased to be the natural clientele for legitimate tax shelters after TRA. The passive loss rules were more effective in curtailing the use of 'abusive' tax shelters; however, it is shown that a more narrowly focused restriction on seller financing of tax sheltered investments could have accomplished the same goal with much less scope for discouraging productive economic investments.

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This chapter was published in:

  • Martin Feldstein & James M. Poterba, 1996. "Empirical Foundations of Household Taxation," NBER Books, National Bureau of Economic Research, Inc, number feld96-1, October.
    This item is provided by National Bureau of Economic Research, Inc in its series NBER Chapters with number 6241.

    Handle: RePEc:nbr:nberch:6241

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    1. Harvey S. Rosen, 1987. "The Marriage Tax is Down But Not Out," NBER Working Papers 2231, National Bureau of Economic Research, Inc.
    2. Gentry, William M., 1994. "Taxes, financial decisions and organizational form : Evidence from publicly traded partnerships," Journal of Public Economics, Elsevier, vol. 53(2), pages 223-244, February.
    3. Daniel Feenberg & Elisabeth Coutts, 1993. "An introduction to the TAXSIM model," Journal of Policy Analysis and Management, John Wiley & Sons, Ltd., vol. 12(1), pages 189-194.
    4. Daniel R. Feenberg & James M. Poterba, 1993. "Income Inequality and the Incomes of Very High-Income Taxpayers: Evidence from Tax Returns," NBER Chapters, in: Tax Policy and the Economy, Volume 7, pages 145-177 National Bureau of Economic Research, Inc.
    5. Feldstein, Martin S & Taylor, Amy, 1976. "The Income Tax and Charitable Contributions," Econometrica, Econometric Society, vol. 44(6), pages 1201-22, November.
    6. Pechman, Joseph A, 1987. "Tax Reform: Theory and Practice," Journal of Economic Perspectives, American Economic Association, vol. 1(1), pages 11-28, Summer.
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    Cited by:
    1. James M. Poterba & Andrew Samwick, 2001. "Household Portfolio Allocation over the Life Cycle," NBER Chapters, in: Aging Issues in the United States and Japan, pages 65-104 National Bureau of Economic Research, Inc.
    2. Joel Slemrod, 1995. "High-Income Families and the Tax Changes of the 1980s: The Anatomy of Behavioral Response," NBER Working Papers 5218, National Bureau of Economic Research, Inc.

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