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The Tax Reform Act Of 1986 And Economic Growth

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  • Patric H. Hendershott

Abstract

Early tax reform proposals listed economic growth as a major goal, and some even gave explicit estimates of the expected increase in the long run output path that would follow from enactment. The 1986 Tax Act does not mention growth, much less give estimates of the expected increase, for good reason. The 1986 Tax Act will likely reduce the long-run output path by two to four percent. A revenue-neutral tax reform that raises the standard deduction and personal exemption cannot, in general, increase the bundle of goods one can purchase with an additional hour worked. Cuts in marginal personal tax rates can be achieved by broadening the tax base and shifting the tax burden to businesses. However, while the after-tax wage will increase, so will the after-tax cost of goods consumed, both currently and in the future, and thus work effort is unlikely to rise. Similarly, a tax reform that shifts the tax burden from labor and existing capital to new investments will likely lower saving and reallocate capital away from industrial uses. While the Tax Act will increase the efficiency of business investment, the potential efficiency gains are so small that actual gains will be swamped by the direct effect of a smaller business capital stock.

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Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 2553.

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Date of creation: Mar 1988
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Publication status: published as Productivity, Growth and the Competitiveness of the AMerican Economy, (Ed) Black, Kluwer Academic Publishers, 1989, pp. 212-150.
Handle: RePEc:nbr:nberwo:2553

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  1. Edgar K. Browning & Jacquelene M. Browning, 1985. "Why Not a True Flat Rate Tax?," Cato Journal, Cato Journal, Cato Institute, vol. 5(2), pages 629-656, Fall.
  2. Steven F. Venti & David A. Wise, 1987. "IRAs and Saving," NBER Chapters, in: The Effects of Taxation on Capital Accumulation, pages 7-52 National Bureau of Economic Research, Inc.
  3. Paul Krugman, 1985. "Fiscal Policy, Interest Rates, and Exchange Rates: Some Simple Analytics," Working papers 391, Massachusetts Institute of Technology (MIT), Department of Economics.
  4. Don Fullerton & Andrew B. Lyon, 1988. "Tax Neutrality and Intangible Capital," NBER Chapters, in: Tax Policy and the Economy: Volume 2, pages 63-88 National Bureau of Economic Research, Inc.
  5. Boskin, Michael J, 1978. "Taxation, Saving, and the Rate of Interest," Journal of Political Economy, University of Chicago Press, vol. 86(2), pages S3-27, April.
  6. Yolanda K. Henderson, 1986. "Lessons from federal reform of business taxes," New England Economic Review, Federal Reserve Bank of Boston, issue Nov, pages 9-25.
  7. Don Fullerton & Yolanda K. Henderson, 1986. "A Disaggregate Equilibrium Model of the Tax Distortions Among Assets, Sectors, and Industries," NBER Working Papers 1905, National Bureau of Economic Research, Inc.
  8. Thomas Downs & Patric H. Hendershott, 1986. "Tax Policy and Stock Prices," NBER Working Papers 2094, National Bureau of Economic Research, Inc.
  9. Michael J. Boskin, 1978. "Taxation, Saving, and the Rate of Interest," NBER Chapters, in: Research in Taxation, pages 3-27 National Bureau of Economic Research, Inc.
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