1978 

compendium 

of tax research 

Office of Tax Analysis . Department of the Treasury · Washi; 1Qton, DC. 20220 
1978 

compendium 

of tax research. 

J]BRARY 

OCT 2 6 1g78 

ROOM 5004 

TREASURY DEPARTMENT 

Office of Tax Analysis· Department of the Treasury· Washington, D.C. 20220 
For sale by the Superintendent of Documents, U.S. Government Printing Office 

Washington, D. C. 20402 

Stock Number 048-000-00316-8 
Foreword 

The Treasury Department has an established program for 

sponsoring research on the effects of the tax system on the U.S. 

economy. The studies presented in this volume are indicative of 

both the wide range of questions covered in this research program and of the value of research in expanding our knowledge 

about tax policy issues. 

The paper by Michael J. Boskin and Lawrence J. Lau reports 

on an attempt to measure empirically the impact of taxes on the 

willingness of individuals to offer their labor and capital services. 

Boskin and Lau employ a life cycle model in which saving, labor 

force participation, and retirement consumption are determined 

simultaneously. They find evidence of economic relationships between the quantities of current and future consumption and leisure that individuals desire and the prices of these quantities. 

They also find a substantial positive relationship between saving 

and the after-tax rate of return. They use their analysis to argue 

that any attempt to quantify the effects of the social security system on savings-without taking into account its impact on the 

labor force participation decision-ignores an important simultaneity. 

The paper by Don Fullerton, John B. Shoven, and John Whalley 

describes work on a general equilibrium model of the U.S. economy currently being developed for the Treasury. The main purposes of the model are to permit an analysis of differential patterns of taxation on the allocation of capital and labor resources 

across industries, and to determine how production patterns will 

change in response to changes in taxes. The authors also quantify 

the efficiency gains that could be derived by equalizing the taxes 

on capital in all industries. Further, the model links information 

on factor incomes and expenditure patterns of typical households, 

thereby allowing differential factor taxes to affect both the distribution of income and its uses. 

(iii) 
IV COMPENDIUM OF TAX RESEARCH 

The p·aper by George S. Tolley and C. Eugene Steuerle analyzes 

the topical issue of energy taxes and deals with three poteqt:ially 

important issues associated with the use of such excise taxes. 

First, how would an increase in excise taxes affect income tax 

revenues? Second, how would an increase in excise taxes affect 

the national income? Third, should excise taxes be deductible from 

personal income under the individual income tax? 

Charles R. Hulten and Frank C. Wykoff discuss analytical 

methods of measuring depreciation. If the depreciation deductions 

allowed for tax purposes differ from the changes in the economic 

value of the depreciable assets, income is mismeasured and there 

are attendant effects on the use of economic resources. In recent 

years there have been several empirical studies of economic depreciation. Wykoff and Hulten have applied sophisticated econometric 

techniques to data on asset prices to develop measures of the economic depreciation of structures. Generally, they find that the 

rate of economic depreciation is roughly half that allowed for tax 

purposes. In contrast to earlier researchers, Wykoff and Hulten 

find evidence that over their useful lives the economic depreciation 

of structures occurs more rapidly than on a pro-rata linear basis. 

The data requirements for many microanalytic models are often 

not contained on a single file; but, composite data files can be 

formed by merging two original files. The paper by Richard S. 

Barr and J. Scott Turner explains a method the authors have 

developed to merge large microdata files relating to individuals 

and households. The potency of their methods is demonstrated in 

their successful merging of a Treasury tax file with a Census file 

containing general characteristics of the population. The basic 

question their method addresses is what information records on 

one file should be associated with the information records on the 

second file, if the merged file is to mirror as closely as possible 

the underlying population which the two files have sampled. The 

generation of accurate merged files is of considerable interest to 

policymakers concerned with such issues as the aggregate revenue 

and distributional effects of taxing items of income not now subject to tax or of granting special exemptions to particular classes 

by expenditures. Turner and Barr first show how their method of 

"optimally" linking data files leads to large scale linear programs 

and then describe a set of computer programs known as the Extended Transportation System for solving such problems. 

The paper by Joseph B. Kadane investigates a number of theoretical statistical problems associated with the notion of merging 

(including the propriety of merging itself) and derives several 
FOREWORD v 

models for optimal merging under a maximum likelihood criterion. 

These fundamental concerns apply to much of the data currently 

used by models for evaluating public policies and have implications for the correct use and interpretation of the statistics that 

these models generate. 

The paper by 0. H. Brownlee examines the question of the "optimal" taxation of foreign-source income; this is, how should taxes 

on foreign-source capital income of U.S. residents be taxed if the 

goal were to maximize U.S. income or some other measure of 

the well-being of U.S. citizens. Brownlee reviews a number of recent studies of international taxation which can shed light on 

the issue. The general conclusion of his review is that different assumptions about production, labor supply, and savings functions 

can produce quite different answers about the optimal tax rate 

on foreign-source capital income. Brownlee argues that in addition to relying on questionable assumptions about elasticities, the 

studies neglect the reaction of foreign governments to U.S. capital 

export taxes as well as the role of capital exported abroad by the 

U.S. Government. Taking account of the capital supplied by the 

U.S. Government via loans and other programs, Brownlee theorizes that under certain ~onditions the optimal rate of foreignsource taxation appears to be roughly 115 percent to 120 percent 

of the domestic rate. He notes that the actual tax rates on foreignsource capital income have been estimated as ranging from 120 

percent to 130 percent of comparable rates on domestic capital 

income. 

Prior to 1976, corporations had an option of electing either an 

overall or a per-country limitation on foreign tax credits. Under 

the option which allowed a single overall limit on creditable foreign taxes paid, excess taxes from relatively high-tax countries 

could offset U.S. tax liability on income earned in relatively lowtax countries. In spite of this, however, the per-country method 

might be preferred by companies with large branch losses in certain countries but with taxable income in others because of differences in the way in which losses were taxed and credits could 

be earned under each of the two systems. The Tax Reform Act of 

1976 placed an overall limitation on foreign tax credits. 

The paper by Thomas Horst describes a simulation model designed to trace the major economic effects of switching from an 

overall to a per-country limitation on the foreign tax credit. 

Horst's work indicates that if the per-country limitation raises the 

tax burden on income from low-tax countries, multinational corporations would limit investment in those countries and expand 
VI COMPENDIUM OF TAX RESEARCH 

those in the United States. However, according to Horst, the 

higher U.S. taxes paid would tend to diminish global investment. 

The substitution and the income effects would combine to reduce 

investments in low-tax countries, with the aggregate investment 

response in the high-tax countries depending on whether the income effect outweighs the substitution effect. 

J. Gregory Ballentine and Charles E. McLure describe work on 

a two-sector general equilibrium model of taxes in which firms can 

explicitly alter their financial policies-particularly their reliance 

on debt finance and the extent of their dividend distributions-as 

personal and corporate tax policies change. They apply their model 

to analyze the incidence of the corporate tax. According to Ballentine and McLure, when changes in financial policy are taken 

into account, owners of corporate stock bear less of the long-run 

burden of the corporate tax than do owners of noncorporate stock. 

They proceed to argue that this suggests that the corporate tax is 

far less progressive than has typically been believed. Ballentine 

and McLure also use their model to analyze the distributional effects of several policies that would reduce the double taxation of 

corporate dividends. 

The paper by T. Nicolaus Tideman analyzes the impact on tax 

neutrality of several tax policies that would move toward the integration of corporate and personal taxes. Tideman asserts that 

neutrality requires that any marginal shift of corporate financing 

between debt and equity should involve no change in Government 

revenues. He argues that the taxation of capital can give rise to 

many types of distortions-between corporate and noncorporate 

activity, dividends and retained earnings, debt and equity financing, individual and institutional financing, and among types of 

assets. His analysis uses a cost-of-capital approach to demonstrate 

the difficulties that may be encountered in attempting to achieve 

neutrality by several forms of integration. 

The paper by Warren Weber attempts to develop quantitative 

measures of how savings in the economy would respond to a tax 

policy change that would integrate the corporate and personal 

taxes. Weber argues that integration would affect savings in three 

ways. First, by changing the interest rate and the taxes on particular types of assets, integration would have a wealth effect 

which would alter individual incentives to save. Second, by lowering the tax on dividends relative to retained earnings, integration 

would diminish the incentives of corporations to retain earnings. 

Third, by reducing taxes, integration would cause revenue loss to 

the Government-a loss that would have to be made up by higher 
FOREWORD VII 

taxes on labor. The higher taxes on labor income would tend to 

reduce saving. According to Weber, integration would increase 

total saving by approximately $9 billion annually. Weber argues 

that the policy question of how tax-exempt institutions and pension funds would be taxed under integration has an important 

bearing on the aggregate savings response to integration. 

I would like to thank all the authors who have contributed to 

this volume. Special thanks should also be given to Mike Kaufman, 

Sue Parker, and Gary Robbins of the Office of Tax Analysis, for 

planning and organizing the publication of this volume. The Blue 

Pencil Group of Reston, Virginia, provided valuable editorial advice. Finally, I wish to thank Amie Powell and Frances Hawkins 

for their extraordinary typing efforts. 

EMIL SUNLEY 

Deputy Assistant Secretary 

Office of Tax Analysis 
Contents 

Taxation and Aggregate Factor Supply: Preliminary Estimates Michael J. Boskin and Lawrence J. Lau .............................. 3 

Comment: Finis Welch 16 

General Equilibrium Analysis of U.S. Taxation Policy 

Don Fullerton, John B. Sh oven, and John Whalley ..................... 23 

Comment: Arnold C. Harberger 59 

The Effect of Excises on the Taxation and Measurement 

of Income George S. Tolley and C. Eugene Steuerle ............... 67 

Comment: Gerard M. Brannon 84 

On the Feasibility of Equating Tax to Economic 

Depreciation Charles R. Hulten and Frank C. Wykoff ......... 91 

Comment: Robert M. Coen 121 

A New, Linear Programming Approach to Microdata File 

Merging, Richard S. Barr and J. Scott Turner................................. 131 

Comment: Alan J. Goldman 150 

Reply: Richard S. Barr and J. Scott Turner 152 

Some Statistical Problems in Merging Data 

Files/ Joseph B. Kadane .......................................................................................... 159 

Comment: Christopher A. Sims 172 

Reply: Joseph B. Kadane 178 

(ix) 
x COMPENDIUM OF TAX RESEARCH 

Optimal Taxation of Foreign-Source Investment 

Income/ 0. H. Brownlee .......................................................................................... 183 

Comment: Gary C. Hufbauer 207 

The Overall Vs. the Per-Country Limitation on the U.S. 

Foreign Tax Credit/ Thomas Horst ............................................................ 213 

Comment: George F. Kopits 237 

Corporate Tax Integration: Incidence and Effects on 

Financial Structure/ J. Gregory Ballentine and 

Charles E. McLure, Jr. ............................................................................................. 243 

Comment: Martin J. Bailey 281 

Reply: J. Gregory Ballentine and 

Charles E. McLure, Jr. 282 

Integration and Investment Incentives/ 

T. Nicolaus Tideman ................................................................................................... 285 

Comment: Marshall E. Blume 300 

Saving and Tax Integration/ Warren E. Weber .............................. 305 

Comment: Robert E. Hall 316