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Fundamental Tax Reform and Corporate Financial Policy

Listed author(s):
  • William M. Gentry
  • R. Glenn Hubbard

How tax reform affects corporate financial decisions helps determine whether reform will increase capital formation and simplify the tax system. This paper describes the effects of fundamental tax reform on corporate tax planning and summarizes economists' knowledge of the magnitude of these effects. We analyze income tax reform, consisting of integrating corporate and personal income taxes, and moving to a broad-based consumption tax. As prototypes of reform, we use the U.S. Treasury's Comprehensive Business Income Tax proposal for income tax reform and the Flat Tax for consumption tax reform. The critical difference between these reforms is that the consumption tax gives firms immediate deductions for capital outlays instead of the depreciation allowances of the income tax. Tax reform can affect organizational form, capital structure, and timing decisions. Our major theme is that the two types of reform will have similar effects on business financial decisions because they both integrate corporate and personal income taxes. Both reforms eliminate the tax differentials between corporate and noncorporate businesses and between debt and equity financing. Since both reforms eliminate investor-level taxes on financial assets, they reduce the effects of taxes on timing decisions associated with financial assets, such as the timing of corporate dividends. How taxes affect these financial decisions have important implications for the incidence of the corporate tax. These reforms also greatly alter the current incentives for tax-motivated financial planning.

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File URL: http://www.nber.org/papers/w6433.pdf
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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 6433.

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Date of creation: Feb 1998
Publication status: published as Tax Policy and the Economy (1999).
Handle: RePEc:nbr:nberwo:6433
Note: CF PE
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National Bureau of Economic Research, 1050 Massachusetts Avenue Cambridge, MA 02138, U.S.A.

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  1. Alan J. Auerbach, 1988. "The Deadweight Loss from `Non-Neutral' Capital Income Taxation," NBER Working Papers 2510, National Bureau of Economic Research, Inc.
  2. James M. Poterba (ed.), 1992. "Tax Policy and the Economy, Volume 6," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262660776, September.
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  4. Ginsburg, Martin D., 1995. "Life Under a Personal Consumption Tax: Some Thoughts on Working, Saving, and Consuming in Nunn-Domenici's Tax World," National Tax Journal, National Tax Association, vol. 48(4), pages 585-602, December.
  5. Titman, Sheridan & Wessels, Roberto, 1988. " The Determinants of Capital Structure Choice," Journal of Finance, American Finance Association, vol. 43(1), pages 1-19, March.
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  13. Darrel Cohen & Kevin Hassett & R. Glenn Hubbard, 1999. "Inflation and the User Cost of Capital: Does Inflation Still Matter?," NBER Chapters, in: The Costs and Benefits of Price Stability, pages 199-234 National Bureau of Economic Research, Inc.
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