Tax Policies and the Real and Financial Decisions of the Firm: the Effects of the Tax Reform Act of 1986

Abstract

This article reviews various models proposed in the literature to estimate the impact of taxation on the real and financial decisions of the firm, and uses one of these models to estimate the impact of the Tax Reform Act of 1986. The model that the authors use is composed of three recursive equations: a dividend payout rate equation, a leverage equation, and an investment equation. The equations are estimated and simulated with U.S. aggregate data. The authors find that the Tax Reform Act of 1986 will increase the dividend payout rate, reduce leverage, and may decrease the after-tax real cost of financing in the long run. On the other hand, mainly because of the removal of the Investment Tax Credit, the authors expect a significant reduction in corporate investment in machinery and equipment in the long run.