THE TIMING OF THE STOCK MARKET REACTION TO RIFLE-SHOT TRANSITION RULES IN THE TAX REFORM ACT OF 1986

As part of the Tax Reform Act of 1986 (TRA86), Congress granted {dollar}10.6 billion of targeted tax breaks to specific taxpayers. Each of these ``rifle-shot'' transition rules was usually written to benefit only one taxpayer and in ambiguous language so that the beneficiaries could not be easily identified. Since millions of tax dollars were often affected by each transition rule, one would normally expect to have seen the share price of a company benefitting from such a rule increase quickly to reflect the tax benefit. However, much secrecy surrounded the environment in which these provisions were granted, making the timing of the stock market reaction to these provisions unclear. An event study investigating the timing of the stock market reaction to rifle-shot transition rules in TRA86 was conducted. There are three critical events of interest pertaining to these tax provisions. The first (dispensation) is the selection of the beneficiaries, when information concerning their identity was not publicly available. The second (public availability) is the public release of the text of TRA86, when one could have read the legislation, including the rifle-shot transition rules in their ambiguous language. Finally, after being pressured to do so, Congress identified the beneficiaries by name (public announcement).; Congress has chosen to disclose the beneficiaries of rifle-shot transition rules ambiguously rather than straightforwardly. While this secrecy may have political advantages for Congress, it may produce outcomes in the stock market which are incongruent with Congressionally espoused goals, and there is no evidence that Congress has considered this possibility at all. The results indicate a weakly significant, positive reaction at dispensation, suggesting possible trading on inside information. No significant reaction was found at public availability, suggesting that the secrecy surrounding rifle-shot transition rules does not give better-informed investors the opportunity to benefit at the expense of less-informed investors. A strongly significant, generally positive reaction was found at public announcement, suggesting that the secrecy surrounding rifle-shot transition rules creates a market friction which may lead to an inefficient allocation of capital in the marketplace.