Tax Policies For the 1990's: Personal Saving, Business Investment, and Corporate Debt

Although the tax reforms of the 1980s substantially lowered the excess burden caused by high marginal tax rates, there were also significant adverse effects on incentives to save and to invest in business plant and equipment. Effective tax rates on. real capital gains and real net interest income remain very high because the tax rules do not recognize the difference between real and nominal magnitudes. These high effective tax rates discourage personal saving. The paper discusses a number of ways in which the tax law could be modified to encourage more saving and less borrowing. Existing tax rules bias corporate decisions in favor of debt finance relative to equity finance and in favor of investments in intangible assets (like advertising, consumer goodwill, and R and D) relative to investments in plant and equipment. The paper discusses the use of a cashflow corporate tax (with complete expensing of investment and no deduction for interest payments) as a way of remedying both of these biases in our current tax law.