Approaches to Efficient Capital Taxation: Leveling the Playing Field vs.Living by the Golden Rule

In this paper we explore the efficiency gains from the Tax Reform Act of 1986 and prospective tax reforms, separating out the intersectoral and intertemporal efficiency consequences. To assess these effects, we employ a general equilibrium model that considers the effects of taxes on the allocation of capital across industries, assets, sectors, and time. We find that the 1986 tax reform yielded only a small improvement in the intersectoral allocation of capital because the beneficial effects from its more uniform treatment of capital within the business sector are largely offset by adverse effects stemming from increased tax disparities between the business and housing sectors. The intertemporal efficiency effects of the reform, in contrast, are significant and negative. Hence the overall efficiency impact of the reform is negative as well. Our results indicate that the economic margins offering the greatest scope for efficiency gains are different from those that received the most attention under the 1986 tax reform. While much of the 1986 reform concentrated on reducing tax disparities within the business sector, much larger efficiency gains would result from reducing tax disparities between the business and housing sectors and from general reductions in effective marginal tax rates on capital.