Tax Changes and Capital Allocation in the 1980s

The paper begins with presentation of a methodology for computing rental costs of capital under any tax regime.Tax law over the 1980-84 period is specified and the provisions of theTreasury and Administration tax reform proposals and HR 3838 are described. A model is then constructed to allow calculation of the impact of changes in tax regimes and/or expected inflation on interest rates and the allocation of real capital. The model allocates a fixed private capital stock among various classes of nonresidential and residential capital, depending upon the rental costs for the capital components, the price elasticities of demand with respect to the rental costs, and the elasticities of homeownership with respect to the cost of owning versus renting. The interest rate adjusts in response to tax/inflation changes so as to maintain the aggregate demand for capital at this initial level.The model is employed to deduce the efficiency of the allocation of real capital under various tax regimes at different inflation rates.