The impact of firm type on tax preference shifting in 1986

The 1986 Tax Reform Act (TRA-86) reduced regular tax rates effective for tax years beginning after 1986. Firms in the highest marginal tax bracket in 1986 had an increased incentive to defer taxable income from 1986 to later years. Scholes, Wilson and Wolfson (1992) found that firms shifted gross margin in anticipation of the reduction in marginal tax rates. This paper extends their work by adding the following considerations to the research design. First, total estimated domestic taxable income is examined as opposed to components of book income. Second, firms likely to be subject to the tax on book income provisions of the alternative minimum tax were controlled for as well as firms that had a low marginal tax status in 1986. The results of this paper are as follows: (1) high marginal tax firms had lower than expected taxable income in 1986 relative to low marginal tax firms; (2) firms likely to be subject to the tax on book income may have had higher than expected book income in 1986 relative to other firms; and (3) the results found in (1) and (2) are independent of each other.