THE ECONOMIC IMPACT OF A TAX LAW CHANGE: PUBLICLY TRADED PARTNERSHIPS UNDER THE REVENUE ACT OF 1987

This paper examines the economic impact of government regulation by studying the effect of one prominent kind of regulation--taxation--on one prominent kind of economic decision making--the valuation of publicly traded securities. This is accomplished by analyzing the capital market's reaction to a tax law change.; The law changes under study in this paper are the legislative changes wrought by Revenue Act of 1987 to the Federal income tax treatment of equity investments in publicly traded partnerships ("PTP's"). These changes significantly reduced the tax advantages of investing in such securities. The market reaction under study is the price behavior of these "shares" of PTP "common stock" around turning points during the legislative progress of the '87 Act.; Positive finance theory predicts that when significant new information becomes public, an abnormal change in the market price of affected securities should occur. Put into the context of taxation, securities prices should be affected if information generated during the tax legislative process is significantly relevant to expectations about the after-tax cash flows generated by investing in these securities. That is, if tax-related information is impounded by the market similar to the process applied to other financial information, abnormal price changes should occur to the extent that such information significantly affects expectations as to either: (1) the probability that tax law changes will occur, or (2) the magnitude of such changes.; Thus, a quick and unbiased reaction is expected in response to disclosures during the legislative process which can be expected to affect investors' expectations of either the probability of a tax law change or the size of the anticipated impact. This information hypothesis was tested by analyzing the price behavior of PTP equity interests traded during the legislative progress of the '87 Act. As hypothesized, this revealed a statistically strong reaction to the most telling information disclosure during the progress of the legislation: its passage out of the pivotal House Ways & Means Committee. Statistically significant reactions to each of the five most important information disclosures also were found at various points during the 121 trading day event window centered on each event.