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The Importance of Measurement Error in the Cost of Capital

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  • Austan Goolsbee

Abstract

Conventional estimates of the impact of taxes on investment may be seriously biased by measurement error in the cost of capital. The existence and size of such error, however, has not been documented. Using panel data on different types of capital equipment, this paper provides direct evidence of measurement error in the tax component of the cost of capital, accounting for about 20 percent of the tax term's variance. Correcting for the error with IV estimation shows that taxes significantly affect both prices and investment and that conventional results may be off by as much as a factor of four.

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Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 7558.

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Date of creation: Feb 2000
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Publication status: published as Goolsbee, Austan. "The Importance Of Measurement Error In The Cost Of Capital," National Tax Journal, 2000, v53(2,Jun), 215-228.
Handle: RePEc:nbr:nberwo:7558

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  1. Martin Feldstein, 1983. "Inflation, Tax Rules, and Investment: Some Econometric Evidence," NBER Chapters, in: Inflation, Tax Rules, and Capital Formation, pages 243-286 National Bureau of Economic Research, Inc.
  2. Austan Goolsbee, 1997. "Investment Tax Incentives, Prices, and the Supply of Capital Goods," NBER Working Papers 6192, National Bureau of Economic Research, Inc.
  3. Auerbach, A.J. & Hines, Jr.J.R., 1988. "Investment Tax Incentives And Frequent Tax Reforms," Papers 135, Princeton, Woodrow Wilson School - Public and International Affairs.
  4. Jane G. Gravelle, 1994. "The Economic Effects of Taxing Capital Income," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262071584, December.
  5. Gilchrist, S. & Himmelberg, C.P., 1995. "Evidence on the Role of Cash Flow for Investment," Papers 95-29, Columbia - Graduate School of Business.
  6. Rosanne Altshuler & Alan J. Auerbach, 1987. "The Significance of Tax Law Asymmetries: An Empirical Investigation," NBER Working Papers 2279, National Bureau of Economic Research, Inc.
  7. Alan J. Auerbach & Martin Feldstein, 1978. "Inflation and the Choice of Asset Life," NBER Working Papers 0253, National Bureau of Economic Research, Inc.
  8. Martin Feldstein & Lawrence Summers, 1983. "Inflation and the Taxation of Capital Income in the Corporate Sector," NBER Chapters, in: Inflation, Tax Rules, and Capital Formation, pages 116-152 National Bureau of Economic Research, Inc.
  9. 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.
  10. Caballero, Ricardo J, 1994. "Small Sample Bias and Adjustment Costs," The Review of Economics and Statistics, MIT Press, vol. 76(1), pages 52-58, February.
  11. Andrew B. Abel & Olivier J. Blanchard, 1983. "The Present Value of Profits and Cyclical Movements in Investment," NBER Working Papers 1122, National Bureau of Economic Research, Inc.
  12. Lyon, Andrew B., 1990. "Investment Incentives under the Alternative Minimum Tax," National Tax Journal, National Tax Association, vol. 43(4), pages 451-65, December.
  13. Griliches, Zvi & Hausman, Jerry A., 1986. "Errors in variables in panel data," Journal of Econometrics, Elsevier, vol. 31(1), pages 93-118, February.
  14. Don Fullerton, 1983. "Which Effective Tax Rate?," NBER Working Papers 1123, National Bureau of Economic Research, Inc.
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Cited by:
  1. Austan Goolsbee, 1998. "Taxes and the Quality of Capital," NBER Working Papers 6731, National Bureau of Economic Research, Inc.
  2. Yoonsoo Lee, 2007. "The Importance of Reallocations in Cyclical Productivity and Returns to Scale: Evidence from Plant-Level Data," Working Papers 07-05, Center for Economic Studies, U.S. Census Bureau.
  3. Shaun K. Roache, 2006. "Domestic Investment and the Cost of Capital in the Caribbean," Applied Econometrics and International Development, Euro-American Association of Economic Development, vol. 6(3).
  4. Shaun K. Roache, 2006. "Domestic Investment and the Cost of Capital in the Caribbean," IMF Working Papers 06/152, International Monetary Fund.
  5. Ramirez Verdugo, Arturo, 2005. "Tax Incentives and Business Investment: New Evidence from Mexico," MPRA Paper 2272, University Library of Munich, Germany, revised 04 Oct 2006.
  6. Anderson, John E., 2012. "State Tax Rankings: What Do They And Don’T They Tell Us?," National Tax Journal, National Tax Association, vol. 65(4), pages 985-1010, December.
  7. Walch, Florian & Dwenger, Nadja, 2011. "Tax Losses and Firm Investment: Evidence from Tax Statistics," Annual Conference 2011 (Frankfurt, Main): The Order of the World Economy - Lessons from the Crisis 48699, Verein für Socialpolitik / German Economic Association.

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