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The Effects of Tax Rules on Nonresidential Fixed Investment: Some Preliminary Evidence from the 1980s

In: The Effects of Taxation on Capital Accumulation

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  • Martin Feldstein
  • Joosung Jun

Abstract

The evidence presented in this study confirms that tax-induced changes in the profitability of investment have had a powerful effect on the share of GNP devoted to nonresidential fixed investment. More specifically, we have reestimated two models of aggregate investment initially presented in Feldstein, "Inflation, Tax Rules and Investment: Some Econometric Evidence,"(Econometrica, 1982). The present study extends the previous analysis byusing revised national income accounts, by improving the estimation of the effective tax rate and the profitability of new investments, and by extending the sample to include the years 1978 through 1984. Despite these changes, the new statistical estimates are remarkably close to the previous results. The statistical estimates are also very robust with respect to sample period, estimation method, and the presence of other variables.The first model relates the investment-GNP ratio to the real net-of-tax rate of return received by the providers of debt and equity capital to the nonfinancial corporate sector and to the rate of capacity utilization. Our estimates imply that each percentage point increase in the real net return raises the investment-GNP ratio by 0.4 percentage points. A one percent age point increase in the net return is equivalent to a ten percentage point reduction in the overall effective tax rate. Since the net nonresidential fixed investment averaged 3 percent of GNP during the past three decades, a ten percentage point tax reduction induces a 13 percent rise in the investment-GNP ratio.Our second model relates the investment-GNP ratio to the difference between the maximum potential net return that firms can support by investing in a "standard investment project" and the net cost of debt and equity capital. The statistical estimates imply that each percentage point change in this measure of the rate of return over cost raises the investment-GNP ratio by 0.3 percentage points or 10 percent of its
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Suggested Citation

  • Martin Feldstein & Joosung Jun, 1987. "The Effects of Tax Rules on Nonresidential Fixed Investment: Some Preliminary Evidence from the 1980s," NBER Chapters, in: The Effects of Taxation on Capital Accumulation, pages 101-162, National Bureau of Economic Research, Inc.
    • Handle: RePEc:nbr:nberch:11347
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    References listed on IDEAS

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    1. Feldstein, Martin S & Rothschild, Michael, 1974. "Towards an Economic Theory of Replacement Investment," Econometrica, Econometric Society, vol. 42(3), pages 393-423, May.
    2. Feldstein, Martin & Dicks-Mireaux, Louis & Poterba, James, 1983. "The effective tax rate and the pretax rate of return," Journal of Public Economics, Elsevier, vol. 21(2), pages 129-158, July.
    3. Martin Feldstein & Lawrence Summers, 1983. "Inflation, Tax Rules, and the Long-term Interest Rate," NBER Chapters, in: Inflation, Tax Rules, and Capital Formation, pages 153-185, National Bureau of Economic Research, Inc.
    4. Martin Feldstein, 1983. "Inflation and the Stock Market," NBER Chapters, in: Inflation, Tax Rules, and Capital Formation, pages 186-198, National Bureau of Economic Research, Inc.
    5. 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.
    6. 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.
    7. Alan J. Auerbach & James R. Hines, Jr., 1987. "Anticipated Tax Changes and the Timing of Investment," NBER Chapters, in: The Effects of Taxation on Capital Accumulation, pages 163-200, National Bureau of Economic Research, Inc.
    8. Feldstein, Martin, 2009. "Inflation, Tax Rules, and Capital Formation," National Bureau of Economic Research Books, University of Chicago Press, number 9780226241791, December.
    9. Merton, Robert C., 1980. "On estimating the expected return on the market : An exploratory investigation," Journal of Financial Economics, Elsevier, vol. 8(4), pages 323-361, December.
    10. Martin Feldstein, 1986. "Budget Deficits, Tax Rules, and real Interest Rates," NBER Working Papers 1970, National Bureau of Economic Research, Inc.
    11. Feldstein, Martin S & Foot, David K, 1971. "The Other Half of Gross Investment: Replacement and Modernization Expenditures," The Review of Economics and Statistics, MIT Press, vol. 53(1), pages 49-58, February.
    12. Abel, Andrew B, 1985. "A Stochastic Model of Investment, Marginal q and the Market Value of the Firm," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 26(2), pages 305-322, June.
    13. Hayashi, Fumio, 1982. "Tobin's Marginal q and Average q: A Neoclassical Interpretation," Econometrica, Econometric Society, vol. 50(1), pages 213-224, January.
    14. Mark Warshawsky, 1982. "Life Insurance Savings and the After-Tax Life Insurance Rate of Return," NBER Working Papers 1040, National Bureau of Economic Research, Inc.
    15. Lucas, Robert Jr, 1976. "Econometric policy evaluation: A critique," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 1(1), pages 19-46, January.
    16. Lawrence H. Summers, 1981. "Taxation and Corporate Investment: A q-Theory Approach," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 12(1), pages 67-140.
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    Cited by:

    1. Joel B. Slemrod, 1990. "Tax Effects on Foreign Direct Investment in the United States: Evidence from a Cross-Country Comparison," NBER Chapters, in: Taxation in the Global Economy, pages 79-122, National Bureau of Economic Research, Inc.
    2. Michael J. Boskin & William G. Gale, 1987. "New Results on the Effects of Tax Policy on the International Location of Investment," NBER Chapters, in: The Effects of Taxation on Capital Accumulation, pages 201-222, National Bureau of Economic Research, Inc.
    3. Hendershott, Patric H & Peek, Joe, 1992. "Treasury Bill Rates in the 1970s and 1980s," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 24(2), pages 195-214, May.
    4. Joosung Jun, 1990. "US Tax Policy and Direct Investment Abroad," NBER Chapters, in: Taxation in the Global Economy, pages 55-78, National Bureau of Economic Research, Inc.
    5. Palle S. Andersen, 1987. "Profit shares, investment and output capacity," BIS Working Papers 12, Bank for International Settlements.
    6. Martin Feldstein & Douglas W. Elmendorf, 1989. "Budget Deficits, Tax Incentives, and Inflation: A Surprising Lesson from the 1983–1984 Recovery," NBER Chapters, in: Tax Policy and the Economy, Volume 3, pages 1-24, National Bureau of Economic Research, Inc.
    7. Steven M. Fazzari & R. Glenn Hubbard & Bruce C. Petersen, 1988. "Financing Constraints and Corporate Investment," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 19(1), pages 141-206.
    8. Michael J. Boskin, 1987. "Tax Policy and the International Location of Investment," NBER Chapters, in: Taxes and Capital Formation, pages 73-82, National Bureau of Economic Research, Inc.
    9. Gastanaga, Victor M. & Nugent, Jeffrey B. & Pashamova, Bistra, 1998. "Host Country Reforms and FDI Inflows: How Much Difference do they Make?," World Development, Elsevier, vol. 26(7), pages 1299-1314, July.
    10. Martin Feldstein & Douglas W. Elmendorf, 1989. "Budget Deficits, Tax Incentives and Inflation: A Surprising Lesson From The 1983-84 Recovery," NBER Working Papers 2819, National Bureau of Economic Research, Inc.
    11. John B. Shoven, 1987. "The Tax Consequences of Share Repurchases and Other Non-Dividend Cash Payments to Equity Owners," NBER Chapters, in: Tax Policy and the Economy, Volume 1, pages 29-54, National Bureau of Economic Research, Inc.

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