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Are Investment Incentives Blunted by Changes in Prices of Capital Goods?

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  • Kevin A. Hassett
  • R. Glenn Hubbard

Abstract

Recent research on business investment decisions suggests that real investment in plant and equipment is quite sensitive to changes in the user cost of capital, pointing to the possibility that long-run changes in tax policy may have a significant impact on an economy's capital stock. Indeed, many countries have at times adopted investment tax incentives to stimulate investment. The prevalence of investment incentives suggests that local policymakers believe that incentives are effective in increasing investment at a reasonable cost in terms of lost revenue for a given increment to investment. In this paper, we explore this issue by estimating the extent to which countries are price-takers in the world market for capital goods. We find that most countries -- even the United States -- likely currently face a highly elastic supply of capital goods, suggesting that the effect of investment incentives on the price of investment goods is small. Hence efforts of long-run changes in investment tax policy are likely to materialize in real investment rather than simply being dissipated in changes in capital-goods prices.

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Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 6676.

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Date of creation: Jun 1999
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Handle: RePEc:nbr:nberwo:6676

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  1. Feldstein, Martin & Horioka, Charles, 1980. "Domestic Saving and International Capital Flows," Economic Journal, Royal Economic Society, vol. 90(358), pages 314-29, June.
  2. Kevin A. Hassett, 2009. "Tax Policy and Investment," Books, American Enterprise Institute, number 24215, 4.
  3. Ricardo J. Caballero & Eduardo M. R. A. Engel & John C. Haltiwanger, 1995. "Plant-Level Adjustment and Aggregate Investment Dynamics," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 26(2), pages 1-54.
  4. Auerbach, Alan J & Hassett, Kevin A & Oliner, Stephen D, 1994. "Reassessing the Social Returns to Equipment Investment," The Quarterly Journal of Economics, MIT Press, vol. 109(3), pages 789-802, August.
  5. Jason Cummins & Trevor Harris & Kevin Hassett, 1995. "Accounting Standards, Information Flow, and Firm Investment Behavior," NBER Chapters, in: The Effects of Taxation on Multinational Corporations, pages 181-224 National Bureau of Economic Research, Inc.
  6. Kravis, Irving B. & Lipsey, Robert E., 1978. "Price behavior in the light of balance of payments theories," Journal of International Economics, Elsevier, vol. 8(2), pages 193-246, May.
  7. Jason G. Cummins & Kevin A. Hassett & R. Glenn Hubbard, 1996. "Tax Reforms and Investment: A Cross-Country Comparison," NBER Working Papers 5232, National Bureau of Economic Research, Inc.
  8. Ricardo J. Caballero, 1997. "Aggregate Investment," NBER Working Papers 6264, National Bureau of Economic Research, Inc.
  9. Cohen, Darrel S. & Hassett, Kevin A., 1999. "Inflation, Taxes, and the Durability of Capital," National Tax Journal, National Tax Association, vol. 52(n. 1), pages 91-98, March Cit.
  10. Officer, Lawrence H., 1986. "The law of one price cannot be rejected: Two tests based on the tradable/nontradable price ratio," Journal of Macroeconomics, Elsevier, vol. 8(2), pages 159-182.
  11. 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.
  12. Martin Feldstein & James R. Hines Jr. & R. Glenn Hubbard, 1995. "The Effects of Taxation on Multinational Corporations," NBER Books, National Bureau of Economic Research, Inc, number feld95-2, October.
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Cited by:
  1. Robert Chirinko & Steven M. Fazzari & Andrew P. Meyer, 2002. "That Elusive Elasticity: A Long-panel Approach to Estimating the Price Sensitivity of Business Capital," Emory Economics 0202, Department of Economics, Emory University (Atlanta).
  2. Hanlon, Michelle & Heitzman, Shane, 2010. "A review of tax research," Journal of Accounting and Economics, Elsevier, vol. 50(2-3), pages 127-178, December.
  3. Zee, Howell H. & Stotsky, Janet G. & Ley, Eduardo, 2002. "Tax Incentives for Business Investment: A Primer for Policy Makers in Developing Countries," World Development, Elsevier, vol. 30(9), pages 1497-1516, September.
  4. Philippe Aghion & Nicholas Bloom & Richard Blundell & Rachel Griffith & Peter Howitt, 2002. "Competition and Innovation: An Inverted U Relationship," NBER Working Papers 9269, National Bureau of Economic Research, Inc.
  5. Robert S. Chirinko & Steven M. Fazzari & Andrew P. Meyer, 2004. "That Elusive Elasticity: A Long-Panel Approach to Estimating the Capital-Labor Substitution Elasticity," CESifo Working Paper Series 1240, CESifo Group Munich.
  6. Karl Whelan, 1999. "Tax incentives, material inputs, and the supply curve for capital equipment," Finance and Economics Discussion Series 1999-21, Board of Governors of the Federal Reserve System (U.S.).

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