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Anticipated Tax Changes and the Timing of Investment

In: The Effects of Taxation on Capital Accumulation

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  • Alan J. Auerbach
  • James R. Hines, Jr.

Abstract

This paper analyzes the short-run and long-run effects of corporate tax changes over the last three decades and the likely consequences of proposed future tax changes. Consideration of short-run effects of tax reform on investment and market value requires a careful analysis of three elements of behavior that are normally omitted from long run analyses: the state of investor expectations, the time lags involved in putting new capital in place, and the tax law's distinctions between new and old capital. The model described in this paper considers investment in equipment and investment in plant separately, and does so under different specifications of investor expectations. Our results for the period 1954-1985 suggest that investors did take account of fluctuations in profitability, real interest rates, and the tax code in making their investment plans. We examine the consequences of the nonindexation of depreciation benefits as well as the introduction of the investment tax credit and the Accelerated Cost Recovery System by simulating the corporate sector's performance in the absence of these features. In addition, we analyze the effects of changing the tax code in 1986 along the lines proposed in the Bradley-Gephardt "Fair Tax" plan, the Treasury II plan, and the Rostenkowski plan, H.R. 3838. The simulation results suggest that all three plans would reduce fixed investment in the short run, with the reduction coming primarily in equipment. At the same time, the simulations predict large wind-falls for existing capital assets under all three reform proposals.
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Suggested Citation

  • 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.
  • Handle: RePEc:nbr:nberch:11348
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    References listed on IDEAS

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    1. 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.
    2. Alan J. Auerbach & James R. Hines Jr., 1986. "Tax Reform, Investment, and the Value of the Firm," NBER Working Papers 1803, National Bureau of Economic Research, Inc.
    3. Abel, Andrew B & Blanchard, Olivier J, 1986. "The Present Value of Profits and Cyclical Movements in Investment," Econometrica, Econometric Society, vol. 54(2), pages 249-273, March.
    4. 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.
    5. Auerbach, Alan J, 1979. "Inflation and the Choice of Asset Life," Journal of Political Economy, University of Chicago Press, vol. 87(3), pages 621-638, June.
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    Cited by:

    1. Brock, Philip L & Turnovsky, Stephen J, 1994. "The Dependent-Economy Model with Both Traded and Nontraded Capital Goods," Review of International Economics, Wiley Blackwell, vol. 2(3), pages 306-325, October.
    2. Sumru Altug & Fanny S. Demers & Michel Demers, 2004. "Tax Policy and Irreversible Investment," CDMA Working Paper Series 200404, Centre for Dynamic Macroeconomic Analysis.
    3. Alan J. Auerbach & Jagadeesh Gokhale & Laurence J. Kotlikoff, 1991. "Generational Accounts: A Meaningful Alternative to Deficit Accounting," NBER Chapters,in: Tax Policy and the Economy, Volume 5, pages 55-110 National Bureau of Economic Research, Inc.
    4. Alan J. Auerbach & David Reishus, 1988. "The Effects of Taxation on the Merger Decision," NBER Chapters,in: Corporate Takeovers: Causes and Consequences, pages 157-190 National Bureau of Economic Research, Inc.
    5. Auerbach, Alan J & Hines, James R, Jr, 1988. "Investment Tax Incentives and Frequent Tax Reforms," American Economic Review, American Economic Association, vol. 78(2), pages 211-216, May.
    6. Matthew D. Shapiro & Christopher L. House, 2006. "Phased-In Tax Cuts and Economic Activity," American Economic Review, American Economic Association, vol. 96(5), pages 1835-1849, December.
    7. Rosanne Altshuler & Jason G. Cummins, "undated". "Tax Policy and the Dynamic Demand for Domestic and Foreign Capital by Multinational Corporations," Computing in Economics and Finance 1997 174, Society for Computational Economics.
    8. Auerbach, Alan J. & Hassett, Kevin, 1992. "Tax policy and business fixed investment in the United States," Journal of Public Economics, Elsevier, vol. 47(2), pages 141-170, March.
    9. Lyon, Andrew B., 1989. "The effect of the investment tax credit on the value of the firm," Journal of Public Economics, Elsevier, vol. 38(2), pages 227-247, March.
    10. Thomas Downs & Patric H. Hendershott, 1986. "Tax Policy and Stock Prices," NBER Working Papers 2094, National Bureau of Economic Research, Inc.
    11. Alan J. Auerbach & Kevin Hassett & Joel Slemrod, 1993. "Taxation and Foreign Direct Investment in the United States: A Reconsideration of the Evidence," NBER Chapters,in: Studies in International Taxation, pages 119-148 National Bureau of Economic Research, Inc.
    12. Francois Gourio & Jianjun Miao, 2011. "Transitional Dynamics of Dividend and Capital Gains Tax Cuts," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 14(2), pages 368-383, April.
    13. Niemann, Rainer & Sureth, Caren, 2008. "Steuern und Risiko als substitutionale oder komplementäre Determinanten unternehmerischer Investitionspolitik?," arqus Discussion Papers in Quantitative Tax Research 51, arqus - Arbeitskreis Quantitative Steuerlehre.
    14. David F. Bradford, 1998. "Transition to and Tax-Rate Flexibility in a Cash-Flow-Type Tax," NBER Chapters,in: Tax Policy and the Economy, Volume 12, pages 151-172 National Bureau of Economic Research, Inc.
    15. Rainer Niemann, 2007. "The Impact of Tax Uncertainty on Irreversible Investment," CESifo Working Paper Series 2075, CESifo Group Munich.
    16. Gordon, Roger & Kalambokidis, Laura & Slemrod, Joel, 2004. "Do we now collect any revenue from taxing capital income?," Journal of Public Economics, Elsevier, vol. 88(5), pages 981-1009, April.
    17. Christopher L. House & Matthew D. Shapiro, 2008. "Temporary Investment Tax Incentives: Theory with Evidence from Bonus Depreciation," American Economic Review, American Economic Association, vol. 98(3), pages 737-768, June.
    18. Louis Kaplow, 2006. "Capital Levies and Transition to a Consumption Tax," NBER Working Papers 12259, National Bureau of Economic Research, Inc.
    19. Francois Gourio & Jianjun Miao, "undated". "Transitional Dynamics of Dividend Tax Reform," Boston University - Department of Economics - Working Papers Series wp2008-021, Boston University - Department of Economics.
    20. 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.
    21. Francois Gourio & Jianjun Miao, 2011. "Transitional Dynamics of Dividend and Capital Gains Tax Cuts," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 14(2), pages 368-383, April.

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