What Do Micro Data Reveal About the User Cost Elasticity?: New Evidence on the Responsiveness of Business Capital Formation
AbstractThe price sensitivity of business investment spending is a central element in economic analysis. A substantial response of capital spending to its user cost, which combines interest, tax, and depreciation rates with relative prices, is critical to evaluating the effectiveness of monetary policy, deficit reduction, and tax reform. In spite of this central role, however, the supporting evidence for a substantial user cost elasticity (UCE) is modest. Several important concerns suggest a downward bias in elasticities estimated from the aggregate data typically employed in UCE research. These biases may arise from firm heterogeneity, measurement error, capital market frictions, and simultaneity. While such biases are theoretically plausible, their empirical importance remains to be substantiated. With a particularly rich data set, containing over 26,000 observations, this paper explores what can be learned about the UCE from micro data. Investment and firm-level control variables are taken from an extensive panel of Compustrat forms. To construct the user cost, we tap a new data source that provides variation across firms as well as across time. A number of the econometric biases mentioned above have a substantial impact on the estimated UCE. After correcting for the biases, we obtain a precisely estimated but small value for the UCE of about -0.25. The effects of capital gain tax cuts and the "flat-tax" proposal on investment are evaluated with this estimated UCE.
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Bibliographic InfoPaper provided by Levy Economics Institute in its series Economics Working Paper Archive with number wp_175.
Date of creation: Nov 1996
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- Robert S. Chirinko & Steven M. Fazzari & Andrew P. Meyer, 1998. "What Do Micro Data Reveal About the User Cost Elasticity?: New Evidence on the Responsiveness of Business Capital Formation," Macroeconomics 9805011, EconWPA.
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