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The Tax Reform Act of 1986 was projected to raise corporate taxes by more than $120 billion over the 1986 to 1991 period. Actual federal corporate tax receipts in the last five years have fallen far short of these projections. This paper explores the factors that have contributed to this shortfall. The most important factor is lower-than-expected corporate profits. The underperformance of corporate profits can be attributed to three principal causes. First, the predicted rates of corporate profits when the 1986 Tax Reform Act was enacted were high by historical standards. The total returns on corporate capital in the U.S. economy in the late 1980s were not as high as the pre-1986 forecasts which underlay initial revenue projections. Second, corporate interests payments were significantly higher, as a share of corporate operating income or GNP, in the late 1980s than in the years leading up to the Tax Reform Act. This reduced the corporate tax base, and may in substantial part ultimately be attributable to the marginal incentive effects for debt and equity finance provided in the 1986 Tax Reform Act. Third, also quite likely in reaction to recent tax changes, the last few years have seen rapid growth in the income reported by Subchapter S corporations. This income is taxed under the individual income tax. The rise of S corporations has, therefore, contributed to the erosion of the corporate income tax.

Why Didn't the Tax Reform Act of 1986 Raise Corporate Taxes?