Taxes and the acquisition of depreciable assets: The Tax Reform Act of 1986 and the alternative minimum tax

Analysis of firm investment behavior during 1982–1993 shows that the Tax Reform Act of 1986 (TRA 86) Public Law No. 99-514 substantially affects both purchases and leases of depreciable assets. The changes in the regular corporate income tax rules are shown to lower asset acquisition. The effect of the alternative minimum tax (AMT) is found to vary with the debt share in firms’ capital structure and with the frequency of AMT exposure during the life of the assets acquired. On average, TRA86 depresses asset purchases less for firms that are subject to the AMT: AMT somewhat mitigates the negative effects of the regular tax rules.     

THE MARKET PRICING OF NET OPERATING LOSS CARRYFORWARDS: IMPLICATIONS OF THE TAX MOTIVATIONS OF MERGERS

An empirical analysis of the market pricing of net operating loss carryforwards (NOLs) and the ability for tax considerations to contribute to mergers and the substantial merger premiums often observed by target firms is presented. The restrictive anti-merger tax-transfer provisions of Section 382 of the Tax Reform Act of 1976 (TRA) serve as the legislative vehicle through which performance differentials of NOL and non-NOL firms are measured. The results of the study are consistent with the hypothesis that NOLs are at least partially priced in the absence of a merger, a fact that suggests that tax-motivated mergers may be more myth than reality. Since the anti-merger tax-transfer penalties contained within the Tax Reform Act of 1986 merely represent incremental increases over those of the TRA, the results of the study remain relevant in the current legislative environment.     

THE MARKET REACTION TO THE 1986 TAX OVERHAUL: A STUDY OF THE CAPITAL GAIN TAX CHANGE

The Tax Reform Act of 1986 (TRA) eliminated the favorable tax treatment on long-term capital gains in the US. Using a standard event study… CONTENTS AND ABSTRACTS 111 methodology, this paper examines daily stock return reactions to the tax overhaul. The results show that high dividend yield stocks earned a significant positive abnormal return and low yield stocks a significant negative return during the legislation period. This finding is consistent with the notion that the TRA made the market valuation of stocks shift in favor of high yield stocks.     

Examining the Impact of the 1986 Tax Reform Act on Corporate Dividend Policy: A New Methodology

This article introduces a new methodology to investigate the effects of the 1986 Tax Reform Act (TRA) on corporate dividend policy. The methodology employs a modified version of Rozeff's (1982) model to control for the potential effect of underlying influential variables. The empirical results show there is no widespread reaction to the 1986 TRA passage on the aggregate level of dividends and only modest support for an industry-related dividend effect. We also find that firm size does not play a significant role in dividend policy reaction to the 1986 TRA.     

Analysts’ earnings forecasting behavior surrounding uncertain regulatory events: evidence from the Tax Reform Act of 1986

This study examines analysts’ forecasting behaviour in the presence of significant tax policy uncertainty. The Tax Reform Act of 1986 (TRA86) was preceded by a lengthy debate, allowing us to investigate how tax policy uncertainty evolves over time. Our results are generally consistent with the intuition that uncertainty precedes the enactment of a proposed tax law while complexity manifests afterwards. Using the repeal of the investment tax credit to identify highly impacted firms, we find that the onset of disagreement among analysts during the debate occurred sooner for highly impacted firms than other firms. We also find that disagreement among analysts was concentrated among highly impacted firms before and after enactment. Given that our sample period precedes Regulation Fair Disclosure, our evidence suggests that analysts relied on private information from management to resolve the uncertainty associated with TRA86 but only for highly impacted firms.     

Taxes and capital structure: evidence from firms' response to the Tax Reform Act of 1986

While the theoretical relation between taxes and capital structurehas been extensively analyzed, the empirical evidence on thisissue has thus far been inconclusive. One of the main difficultiesconfronting previous empirical studies of the cross-sectionalrelationship between taxes and leverage was the control of interveningvariables. The Tax Reform Act of 1986 (TRA), which drasticallychanged the tax regime, provides a unique opportunity to assessthe interaction between taxes and leverage decisions in a controlledenvironment. We test the relationship between leverage and certaintax-related variables for a large sample of companies in theyears surrounding the enactment of the TRA. The results supportthe tax-based theories of capital structure. The findings indicatethat there exists a substitution effect between debt and nondebttax shields, and that both corporate and personal tax ratesaffect leverage decisions.     

Dividend taxation and corporate investment: a comparative study between the classical system and imputation system of dividend taxation in the United States and Australia

In recent times a number of countries have initiated some important tax reforms to eliminate the distortions of double taxation. In this context, Australia adopted a dividend imputation system in 1987, while the US employed the 1986 Tax Reform Act (TRA). The analysis in this paper examines the effects on the level of corporate capital investment, on proxies for corporate tax rates, financial leverage, liquidity, capital intensity and firm size after controlling for the tax reforms. The empirical results provide evidence that: (1) dividend imputation as introduced in Australia is an effective way to reduce the distortions caused by the traditional system of taxation. (2) Compared with the TRA, dividend imputation has been better able to positively stimulate corporate capital investment. (3) TRA effect on corporate investment is more pronounced in the US for firms having a net operating loss. (4) Individual tax rates play a role in corporate investment decisions in both the US and Australia.

AMTexpert: An Expert Decision Support System for the Corporate Alternative Minimum Tax

AMTexpert is a prototype of an expert decision support system (EDSS) for the corporate alternative minimum tax (AMD. The corporate AMT was introduced as part of the Tax Reform Act of 1986 in order to force US corporations to pay more tax. The complicated and interrelated nature of the AMT system has made compliance and planning even more difficult for corporate taxpayers. Given the complexities of the corporate AMT, significant benefits may accrue from the development of an EDSS. In effect, an EDSS combines the judgmental benefits of an expert system (ES) with the computational benefits of a decision support system (DSS). AMTexpert is menu driven with six interdependent phases. The heart of the system is a ‘scoreboard’ used to compare and evaluate alternative tax positions. Context-sensitive advice and explanations are provided to guide the user. The system was validated and evaluated by two groups of outside experts. AMTexpert demonstrates that an EDSS may be developed from existing tax and systems software.     

A Tax-Induced Clientele for Index-Linked Corporate Bonds

This paper analyzes the circumstances under which tax considerations favor or disfavor the use of index-linked corporate bonds. Using a model similar to Miller's, investors' choices of assets depend on their tax preferences for interest income versus capital gains and their preferences for the timing of returns. It is concluded that the absence of index-linked bonds in the U.S. cannot be attributed solely to tax reasons. However, following the 1986 Tax Reform Act, the tax code is expected to disfavor the use of index-linked bonds.     

Tax Policy and Shareholder Wealth: Some Evidence from the Tax Reform Act of 1986

This paper presents additional evidence regarding the stock market reaction to the Tax Reform Act (TRA) of 1986. A prediction model of the change in the profitability index for thirty-three industry groups as a result of the TRA is developed. This prediction model is then tested by examining abnormal industry returns surrounding the announcement of the TRA. The authors find that the distribution of the abnormal returns is related to the distribution of the predicted changes in industry equity investment returns, which suggests that the stock market was efficient in the pricing of news related to the TRA of 1986.     

Capital Gains Taxation and Stock Market Activity: Evidence from IPOs

Prior to the Tax Reform Act of 1986 (TRA '86), long-term capital gains were taxed at a lower rate than short-term gains, presenting investors with an opportunity to increase their after-tax return by delaying the sale of appreciated assets until after they qualified for long-term status and selling depreciated assets prior to long-term qualification. Using a sample of Initial Public Offerings, I find that stocks that appreciated prior to long-term qualification exhibit increased volume and decreased returns just after their qualification date, while stocks that depreciated prior to long-term qualification exhibit these effects just prior to their qualification date.     

FURTHER EVIDENCE ON DIVIDEND YIELDS AND THE EX-DIVIDEND DAY STOCK PRICE EFFECT

Ex-dividend day stock price behavior supports a tax clientele effect. This effect is still found after the Tax Reform Act of 1986. Results reflect an effective tax advantage for capital gains taxes payable at realization, versus dividend taxes due quarterly. Evidence also supports short-term trader participation in the ex-day phenomenon when the difference between dividend income and the ex-dividend-day price decrease exceeds transactions costs to trade. Results contradict prior research where a tax clientele effect is not found, but align with this prior research when including a small number of contaminated observations.     

Capital Structure Determinants in Real Estate Limited Partnerships

This paper models the capital structure decision facing partnerships and tests the implications using panel-data regression analysis for a sample of real estate limited partnerships. The model shows that if an optimal capital structure exists for non-taxed firms, it is a function of personal tax effects, costs of financial distress, and substitute tax shields. The empirical tests indicate a positive relationship between leverage and the proportion of real estate assets held, and a negative relationship between leverage and both growth rates and non-debt tax shields. Furthermore, the findings suggest that changes resulting from the Tax Reform Act of 1986 are positively related to partnership leverage.     

Shareholder taxation and aggregate dividend payout: Evidence from the tax reform act of 1986

The effect of shareholder taxation on corporate dividend policy is a major controversy in financial economics. The Tax Reform Act of 1986 eliminated the statutory tax disadvantage of dividends versus long-term capital gains for individual shareholders. Using aggregate time series data I find evidence that corporate dividend payout has become more generous in the period after tax reform.     

Are There Tax Effects in the Relative Pricing of U.S. Government Bonds?

We investigate the impact of the Tax Reform Act of 1986 on the relative pricing of U.S. Treasury bonds. We obtain positive statistically and economically significant estimates for the implicit tax rates of a “representative” investor in the late 1970s and early 1980s. After the 1986 Tax Reform, the point estimates for the tax rate are close to zero. Tests for a regime shift associated with the 1986 Tax Reform support the hypothesis that this event largely eliminated tax effects from the term structure. We discuss both institutional and statutory explanations for this change.     

Tax and Regulatory Motivations for Issuing Non-voting, Non-convertible Preferred Stock

This paper extends prior studies that attempt to explain the existence of unique securities, particularly Engel, Erickson, and Maydew [1999], by investigating why firms issue non-voting, non-convertible preferred stock (PS) instead of other securities. We find that the choice of PS is influenced by tax and regulatory changes imposed by the Tax Reform Act of 1986 (TRA86) and the 1989 Basle Banking Accord as well as various firm specific incentives. We find that industrials issue PS to preserve tax attributes by avoiding an ownership change and to maximize foreign tax credit utilization. In addition, we find that the regulatory requirements of the Basle Accord influence the choice by banks to issue PS. Finally, we show that although firms could have issued alternative securities that would have allowed them to achieve the same tax or regulatory goals, firm specific factors limit their ability to do so. For example, firms can also avoid triggering an ownership change by issuing straight debt, however, financial distress considerations may constrain their ability to issue additional debt. Therefore, we demonstrate that the final choice of PS is influenced by a combination of tax, regulatory, and firm specific incentives.     

THE EFFECT OF THE 1986 TAX REFORM ACT ON EX-DIVIDEND DAY RETURN BEHAVIOR

In this study I examine whether the Tax Reform Act of 1986 has an effect on ex-date stock return behavior. Results indicate that the tax reform has a significant effect on ex-date returns for NASDAQ stocks, but not for NYSE/AMEX stocks. Further analysis suggests that the ex-date returns on NASDAQ stocks are primarily determined by the tax premium. However, the ex-date returns on NYSE/AMEX stocks are more influenced by short-term trading.     

A welfare evaluation of the 1986 tax reform for married couples in the United States

This paper evaluates the welfare effects of the 1986 Tax Reform Act (TRA86). We rely on different welfare metrics, which fully retain preference heterogeneity and are based on different ethical priors. We estimate utility functions with preference heterogeneity on the basis of structural models of family labor supply. Then, using these estimated preferences, we compute and compare different well-being rankings corresponding to different ways of measuring well-being. Finally, we identify the losers and the winners of TRA86, in absolute and relative terms, for each of the welfare metrics.     

How Firms Make Capital Expenditure Decisions: Financial Signals, Internal Cash Flows, Income Taxes and the Tax Reform Act of 1986

This paper empirically assesses the determinants of future net capital expenditures for a broad cross-section of COMPUSTAT firms from 1973 to 1989. We explore three general categories of factors expected to affect investment: (1) external equity financing, (2) internally generated accounting information, and (3) tax incentives. We find that external financing and information plays a role in that both positive stock returns and equity issuances indicate future increases in investment. The results suggest that high stock prices not only lower the cost of capital, but also signal good investment opportunities. Accounting information about internal sources and uses of funds are also important in the investment decision. In particular, net income and depreciation are positive indicators of future investment while there is a tradeoff between the payment of dividends and investment. Further, positive changes in available cash liquidity also motivate future investment. While taxes are not important in the investment decision on average, we find that firms with previously higher income taxes invested substantially more in 1985 and 1986. This coincides with the repeal of the investment tax credit and the accelerated depreciation schedules in the Tax Reform Act of 1986. We view this as evidence that federal tax policy in the 1980's induced firms with high income tax obligations to accelerate capital expenditures just before the favorable tax treatment of capital expenditures was eliminated.     

Ex-Dividend Day Stock Price Behavior: The Case of the 1986 Tax Reform Act*

This paper analyzes the behavior of stock prices around ex-dividend days after the implementation of the 1986 Tax Reform Act that dramatically reduced the difference between the tax treatment of realized long-term capital gains and dividend income in 1987 and completely eliminated the differential in 1988. We show that this tax change had no effect on the ex-dividend stock price behavior, which is consistent with the hypothesis that long-term individual investors have no significant effect on ex-day stock prices during this time period. The results indicate that the activity of short-term traders and corporate traders dominates the price determination on the ex-day.