The Extent of Implicit Taxes at the Corporate Level and the Effect of TRA86

We examine the extent of implicit taxes at the corporate level and the effect on implicit taxes of the Tax Reform Act of 1986 (TRA86) in the United States. Using a variety of specifications, we find consistent evidence that implicit taxes eliminated virtually all of the cross-sectional differences in explicit tax preferences prior to TRA86, and then abruptly declined and eliminated only about one-third of the cross-sectional differences in tax preferences in years following TRA86. We triangulate this evidence that implicit taxes declined following TRA86 by also providing evidence (a) of a decline in the relation between changes in tax preferences and changes in pre-tax returns, (b) of an increase in the persistence of tax-related earnings changes, and (c) that these dramatic economic changes are priced by investors. Finally, we provide evidence suggesting that the decline in implicit taxes after TRA86 was driven at least in part by expansion of aggressive tax planning and use of tax shelters. Taken together, these results indicate that TRA86 has had a profound and lasting effect on implicit taxes at the corporate level.