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Tax Policy and Irreversible Investment

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Author Info
Sumru Altug
Fanny S. Demers
Michel Demers

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Abstract

We examine the impact of tax policy uncertainty on the irreversible investment decisions of a monopolistically competitive firm. We consider the impact of tax policy in terms of the investment tax credit (ITC) as well as the stochastic tax wedge which determines the after-tax costs of investing. We show that (i) temporary tax incentives have a greater stimulative impact on investment; (ii) greater policy volatility results in greater variability of investment; (iii) a stochastically larger future tax policy lowers current investment; and (iv) greater variability of tax policy around a constant mean leads to lower investment. We examine changes in the average levels of investment and its variability over short- and long-run horizons. We consider a general 3-state process, a log-normal process, and a Poisson process. We carry out an extensive sensitivity analysis that allows us to examine the impact of changes in real interest rates, and changes in the elasticity of demand facing firms.

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Paper provided by Centre for Dynamic Macroeconomic Analysis in its series CDMA Working Paper Series with number 0404.

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Date of creation: Nov 2004
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Handle: RePEc:san:cdmawp:0404

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Related research
Keywords: Irreversible investment; tax policy; changes in persistence; increases in risk.;

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Find related papers by JEL classification:
E22 - Macroeconomics and Monetary Economics - - Macroeconomics: Consumption, Saving, Production, Employment, and Investment - - - Capital; Investment; Capacity
E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy

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Cited by:
(explanations, 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.)

  1. Sumru Altug & Fanny S. Demers & Michel Demers, 2001. "The Impact of Tax Risk and Persistence on Investment Decisions," Economics Bulletin, Economics Bulletin, vol. 5, pages 1-5. [Downloadable!]
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