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The investment tax credit and irreversible investment

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  • Altug, Sumru
  • Demers, Fanny S.
  • Demers, Michel

Abstract

We examine the impact of random changes in investment tax credit (ITC) policy on the irreversible investment decisions of a monopolistically competitive firm facing demand uncertainty. We examine the impact of increases in risk and changes in persistence in the ITC policy on investment behavior. Our results indicate that a temporary ITC (lower policy persistence) generally increases the variability of investment both in the short and the long-run. It lowers investment in the short-run and raises it in the long-run. Thus, perhaps surprisingly, a temporary ITC does not always lead to higher investment but always leads to more volatile investment. Policy-makers may thus face a long-run trade-off between the level and the volatility of investment. We also find that increases in risk defined in terms of mean-preserving spreads may lead to lower investment.

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Bibliographic Info

Article provided by Elsevier in its journal Journal of Macroeconomics.

Volume (Year): 31 (2009)
Issue (Month): 4 (December)
Pages: 509-522

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Handle: RePEc:eee:jmacro:v:31:y:2009:i:4:p:509-522

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Web page: http://www.elsevier.com/locate/inca/622617

Related research

Keywords: Irreversible investment Investment tax credit Tax policy Changes in persistence Increases in risk;

References

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  1. Cherian, Joseph A & Perotti, Enrico C, 1999. "Option Pricing and Foreign Investment under Political Risk," CEPR Discussion Papers 2327, C.E.P.R. Discussion Papers.
  2. Abel, Andrew B., 1982. "Dynamic effects of permanent and temporary tax policies in a q model of investment," Journal of Monetary Economics, Elsevier, vol. 9(3), pages 353-373.
  3. Demers, Michel, 1991. "Investment under Uncertainty, Irreversibility and the Arrival of Information over Time," Review of Economic Studies, Wiley Blackwell, vol. 58(2), pages 333-50, April.
  4. Tauchen, George, 1986. "Finite state markov-chain approximations to univariate and vector autoregressions," Economics Letters, Elsevier, vol. 20(2), pages 177-181.
  5. Aizenman, Joshua & Marion, Nancy P, 1993. "Policy Uncertainty, Persistence and Growth," Review of International Economics, Wiley Blackwell, vol. 1(2), pages 145-63, June.
  6. Filardo, Andrew J, 1994. "Business-Cycle Phases and Their Transitional Dynamics," Journal of Business & Economic Statistics, American Statistical Association, vol. 12(3), pages 299-308, July.
  7. Christina D. Romer & David H. Romer, 2007. "The Macroeconomic Effects of Tax Changes: Estimates Based on a New Measure of Fiscal Shocks," NBER Working Papers 13264, National Bureau of Economic Research, Inc.
  8. Sumru G. Altuğ & Fanny S. Demers & Michel Demers, 2007. "Political Risk and Irreversible Investment," Koç University-TUSIAD Economic Research Forum Working Papers 0707, Koc University-TUSIAD Economic Research Forum.
  9. Steven R. Grenadier, 2002. "Option Exercise Games: An Application to the Equilibrium Investment Strategies of Firms," Review of Financial Studies, Society for Financial Studies, vol. 15(3), pages 691-721.
  10. Lucas, Robert Jr, 1976. "Econometric policy evaluation: A critique," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 1(1), pages 19-46, January.
  11. Hassett, Kevin A. & Hubbard, R. Glenn, 2002. "Tax policy and business investment," Handbook of Public Economics, in: A. J. Auerbach & M. Feldstein (ed.), Handbook of Public Economics, edition 1, volume 3, chapter 20, pages 1293-1343 Elsevier.
  12. Altug, Sumru, 1993. "Time-to-Build, Delivery Lags, and the Equilibrium Pricing of Capital Goods," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 25(3), pages 301-19, August.
  13. Kevin A. Hassett & Gilbert E. Metcalf, 1998. "Investment With Uncertain Tax Policy: Does Random Tax Policy Discourage Investment?," Discussion Papers Series, Department of Economics, Tufts University 9823, Department of Economics, Tufts University.
  14. Bizer, David S & Judd, Kenneth L, 1989. "Taxation and Uncertainty," American Economic Review, American Economic Association, vol. 79(2), pages 331-36, May.
  15. Sumru Altug & Fanny S. Demers & Michel Demers, 2004. "Tax Policy and Irreversible Investment," CDMA Working Paper Series 200404, Centre for Dynamic Macroeconomic Analysis.
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Cited by:
  1. Unal Zenginobuz & Sumru Altug, 2009. "What has been the Role of Investment in Turkey's Growth Performance?," Working Papers 2009/02, Bogazici University, Department of Economics.

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