In models with irreversible investment, increasing uncertainty about prices has been shown to increase the required rate of return (hurdle rate) and delay investment (e.g., Pindyck, 1988). One serious form of uncertainty faced by firms, a form that policy makers could conceivably control, is tax uncertainty. In this paper, we show that it does not follow from past work that tax policy uncertainty increases the expected hurdle price ratio and delays investment. This is because tax uncertainty has an unusual form that distinguishes it from price uncertainty: tax rates tend to remain constant for many years, and then change in large jumps. When tax policy follows a jump process, firms' expectations of the likelihood of the jump occurring have important effects on investment. Indeed, as we show below, while price uncertainty increases the hurdle rate and slows down investment, tax uncertainty has the opposite effect.
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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number
4780.
Length: Date of creation: Jun 1994 Date of revision: Handle: RePEc:nbr:nberwo:4780
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Find related papers by JEL classification: H2 - Public Economics - - Taxation, Subsidies, and Revenue H3 - Public Economics - - Fiscal Policies and Behavior of Economic Agents
References listed on IDEAS Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
Caballero, Ricardo J & Pindyck, Robert S, 1996.
"Uncertainty, Investment, and Industry Evolution,"
International Economic Review,
Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 37(3), pages 641-62, August.
Other versions:
Ricardo J. Caballero, 1997.
"Aggregate Investment,"
NBER Working Papers
6264, National Bureau of Economic Research, Inc.
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