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Investment with Uncertain Tax Policy: Does Random Tax Policy Discourage Investment?

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  • Hassett, Kevin A
  • Metcalf, Gilbert E

Abstract

The authors consider the impact of tax policy uncertainty on firm level and aggregate investment, comparing investment behavior when uncertainty is due to a shock following geometric Brownian motion (GBM) versus when random discrete jumps in tax policy occur. Expectations of the likelihood of a tax policy switch have an important negative impact on the gain to delaying investment in the latter model and time to investment can fall with increasing tax policy uncertainty. Aggregate investment simulations indicate that capital formation is adversely affected by increases in uncertainty in the traditional GBM model but can be enhanced in the jump process model.

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Bibliographic Info

Article provided by Royal Economic Society in its journal The Economic Journal.

Volume (Year): 109 (1999)
Issue (Month): 457 (July)
Pages: 372-93

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Handle: RePEc:ecj:econjl:v:109:y:1999:i:457:p:372-93

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  1. Andrew B. Abel, 1984. "A Stochastic Model of Investment, Marginal q and the Market Value of theFirm," NBER Working Papers 1484, National Bureau of Economic Research, Inc.
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  14. Pindyck, Robert S, 1993. "A Note on Competitive Investment under Uncertainty," American Economic Review, American Economic Association, vol. 83(1), pages 273-77, March.
  15. Lucas, Robert Jr, 1976. "Econometric policy evaluation: A critique," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 1(1), pages 19-46, January.
  16. Jason G. Cummins & Kevin A. Hassett & R. Glenn Hubbard, 1994. "A Reconsideration of Investment Behavior Using Tax Reforms as Natural Experiments," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 25(2), pages 1-74.
  17. Abel, Andrew B, 1983. "Optimal Investment under Uncertainty," American Economic Review, American Economic Association, vol. 73(1), pages 228-33, March.
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