If fully implemented, a revenue-neutral modified flat tax can be expected to lower the economy-wide marginal tax rate and thus accelerate economic growth. Its effects on particular industry groups, however, will be moderated by the elimination of the investment tax credit (ITC) and the lengthening of depreciation schedules—two proposals shared by all three major versions of the modified flat tax. Industries, which currently face different effective tax rates because of provisions for accelerated depreciation and the ITC, may be expected to experience substantial shifts in relative performance.
To determine which industries are likely to benefit the most from the tax reform package, industries must be categorized according to the ease with which they can vary production in response to shifting demand (their elasticity) and according to their sensitivity to changes in the tax on capital. Because the modified flat tax is expected to raise the effective marginal tax rate on capital relative to labor income, industries with low capital tax sensitivity (low CATS) should outperform those with high CATS.
The analysis suggests certain portfolio strategies for a modified flat tax environment. In particular, low CATS industries should outperform high CATS industries. Within the group of inelastic industries, low CATS industries should outperform high CATS industries. Within the elastic industries, low CATS industries should outperform high CATS industries. Within the low CATS industries, the inelastic industries should outperform the elastic industries. Within the high CATS industries, elastic industries should outperform inelastic industries.