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

  • Hassett, Kevin A
  • Hubbard, R Glenn

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 policy-makers believe these are effective in increasing investment at a reasonable cost in terms of lost revenue. 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--face a highly elastic supply of capital goods, suggesting that the effect of investment incentives on the price of investment goods is small. Hence effects 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. Copyright 1998 by Blackwell Publishers Ltd.

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Article provided by Wiley Blackwell in its journal International Finance.

Volume (Year): 1 (1998)
Issue (Month): 1 (October)
Pages: 103-25

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Handle: RePEc:bla:intfin:v:1:y:1998:i:1:p:103-25
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  1. Cummins, J.G. & Hassett, K.A. & Hubbard, R.G., 1995. "tax Reforms and Investment: A Cross-Country Comparison," Working Papers 95-28, C.V. Starr Center for Applied Economics, New York University.
  2. Irving B. Kravis & Robert E. Lipsey, 1977. "Price Behavior in the Light of Balance of Payments Theories," NBER Working Papers 0181, National Bureau of Economic Research, Inc.
  3. 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.
  4. Cabalero, R.J., 1997. "Aggregaete Investment," Working papers 97-20, Massachusetts Institute of Technology (MIT), Department of Economics.
  5. 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.
  6. Jason G. Cummins & Trevor S. Harris & Kevin A. Hassett, 1994. "Accounting Standards, Information Flow, and Firm Investment Behavior," NBER Working Papers 4685, National Bureau of Economic Research, Inc.
  7. 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.
  8. Alan J. Auerbach & Kevin A. Hassett & Stephen D. Oliner, 1993. "Reassessing the Social Returns to Equipment Investment," NBER Working Papers 4405, National Bureau of Economic Research, Inc.
  9. 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.
  10. Feldstein, Martin & Horioka, Charles, 1980. "Domestic Saving and International Capital Flows," Economic Journal, Royal Economic Society, vol. 90(358), pages 314-29, June.
  11. Irving B. Kravis & Robert E. Lipsey, 1971. "Price Competitiveness in World Trade," NBER Books, National Bureau of Economic Research, Inc, number krav71-1, November.
  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, November.
  13. Kevin A. Hassett & R. Glenn Hubbard, 1996. "Tax Policy and Investment," NBER Working Papers 5683, National Bureau of Economic Research, Inc.
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